Structuring Financeable Ground Leases and...

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Structuring Financeable Ground

Leases and Leasehold Mortgages Balancing Competing Interests Among Owners, Lessees and Lenders

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, JULY 9, 2015

Teryl R. Gorrell, Attorney, Gorrell Giles Gollata, Denver

Marc S. Intriligator, Member, Cozen O'Connor, New York

The Practical Real Estate Lawyer | 7

Joshua Stein

The fallout has not been as bad as most people expected.

In 2003, many leasehold mortgagees and their counsel seemed to fear the sky was falling when the Seventh Cir-cuit issued its decision in Precision Industries v. Qualitech, 327 F.3d 537 (7th Cir. 2003). Now that Qualitech has become part of the vocabulary in the leasehold lending community, has this case created the carnage that many commentators feared? How have the courts dealt with the issues that arose in Qualitech? Was the case as bad as many commentators said it was? Shortly after Qualitech, an earlier version of this article argued that the case posed no cause for great concern and did not warrant the frenzy that it seemed to prompt. The present article updates the first one. As before, this article starts by explaining the facts and legal conclusions of the Qualitech case. It summarizes how some other commentators reacted with shock to Qualitech, and why the author held—and still holds—a different view. Finally, the current article explores how the courts have handled the issues that arose in Qualitech, a history that the author believes confirms his original view: lease-hold lenders have nothing to fear from Qualitech. When a lender accepts a ground lease as collateral for a commercial mortgage loan, the lender fears, above all, the risk that somehow the ground lease might terminate

Joshua Stein,a real estate and finance partner with Latham & Watkins LLP and a member of ACREL, has pub-lished extensively on commercial real estate law and practice, including over 150 articles and four books. For more information or to communicate with the author, visit www.josh-uastein.com. An earlier version of this article appeared in the Spring 2004 issue of Shopping Center Legal Update, published (online only) by International Council of Shopping Centers, 1221 Avenue of the Americas, New York, NY 10020, (646) 728-3800. It also appeared in the July 2004 issue of The Practical Real Estate Lawyer. This article was updated and appeared in the program book for the TexasBarCLE Ad-vanced Real Estate Law Course 2008 held in San Antonio on July 10-12, 2008. The author acknowledges with thanks the helpful editorial comments he received from his colleagues Jen-nifer Alter, Richard L. Chadakoff, Jason S. Frank, James I. Hisiger, Elizabeth Jaffe, and Michelle V. Kelban; from Alfredo R. Lagamon, Jr., formerly of Baker & McKenzie LLP; and from Donald H. Op-penheim, Meyers Nave PC, Oakland, California. Copyright 2009, Joshua Stein.

Did The Sky Fall On Leasehold Mortgagees? Ground Lease Financing After Qualitech

8 | The Practical Real Estate Lawyer March 2009

prematurely—and with it, the lender’s entire col-lateral. Any long-term tenant under a ground lease shares similar fears, but lenders worry about them more than tenants do. Lenders and their lawyers therefore insist that ground leases contain extensive protections so the landlord cannot readily terminate the lease. Through these protections, lenders try to eliminate or control every known risk of premature lease ter-mination. See, e.g., Joshua Stein, How Much Protection Does A Leasehold Mortgagee Need?, 19 Prac. Real Est. Law. 7 (Nov. 2003). Qualitech caused an uproar in the lending com-munity because many feared the decision created a new and previously unknown risk of premature lease termination, by giving bankrupt landlords a new and previously unknown way to terminate a ground lease. The mere possibility of that result al-legedly turned some lenders away from leasehold financing transactions, at least for a while. Commentators’ opined rapidly and widely on the implications of Qualitech. A few (including the author) thought there was no reason for Qualitech to create the frenzy that it did, because the case stood for nothing more than the principle that a tenant must pay attention and object early and often and request protection of its interest in its landlord’s bankruptcy. See, e.g., John C. Murray, Bankruptcy Court Holds Tenant’s Rights Must be Protected When Landlord-Debtor Attempts to Sell Property Free and Clear of Lease (2005), http://www.firstam.com/content.cfm?id=3030; see also John C. Murray, Precision In-dustries Part I: Debtor-Lessor’s Property May Be Sold “Free and Clear” of Unexpired Lease, 18 Prob. & Prop. 10, 14-15 (Mar./Apr. 2004). The majority, however, disagreed. Most com-mentators argued that Qualitech would give any landlord in bankruptcy the right to sell a ground leased location to a third party “free and clear” of the ground lease—without compensating the ten-ant for the loss of its lease. If this were true, such

an outcome would, of course, be a disaster for any leasehold mortgagee. Here are the facts of Qualitech as the court sum-marized them. Qualitech leased land to Precision for 10 years, at nominal rent. Precision built a warehouse on the land. Within a year after signing the lease, Qual-itech filed for chapter 11 bankruptcy protection. The Bankruptcy Code says any company in bankruptcy (a “debtor”) can, with court approval, raise money by selling its property free and clear of any “interests” of other parties in the same prop-erty. Qualitech proposed just such a sale for the site that Qualitech had leased to Precision. Precision did not object in any way to the proposal. Precision said nothing. Precision did nothing. The court then authorized Qualitech to sell the leased site. Treat-ing Precision’s leasehold as an “interest” in the asset being sold, the court allowed Qualitech to sell the site free and clear of that leasehold. (The court’s willingness to treat the leasehold as an “interest” raised some eyebrows in the bankruptcy commu-nity, unjustifiably in the writer’s opinion. That issue lies outside the present discussion. The author be-lieves it is intuitively obvious that a leasehold con-stitutes an “interest” in real property.) The buyer, the successful bidder at the bank-ruptcy sale, said the bankruptcy sale terminated Precision’s leasehold. Therefore the buyer locked Precision out of the warehouse on the leased site. As an aside, the buyer was none other than, in effect, Qualitech’s bank group, holder of a huge first mortgage on the property. Qualitech, supra, 327 F.3d at 541. One might reasonably assume that the mortgage had priority over Precision’s lease and no nondisturbance agreement existed (although the case report says nothing on either point). On those assumptions, the mortgagee could easily have structured its acquisition of the site in a way that preserved the mortgage and therefore the ability to foreclose out Precision in a foreclosure sale—a re-sult not too different from what actually happened.

http://www.firstam.com/content.cfm?id=3030

http://www.firstam.com/content.cfm?id=3030

Lease Financing After Qualitech | 9

And if Precision and the bank group had entered into a nondisturbance agreement, it typically would require the mortgagee to honor Precision’s lease after “foreclosure.” But a typical nondisturbance agreement probably would not have required the mortgagee, or its wholly owned subsidiary, to hon-or the lease as the successful bidder at a section 363 sale. Tenants negotiating future nondisturbance agreements might want to cover that possibility. Although Precision had not mortgaged its leasehold, if it had done so, then the section 363 sale would have destroyed the mortgagee’s entire collateral—a leasehold lender’s worst nightmare come true. If, in fact, a debtor landlord could, through a court-ordered bankruptcy sale, readily sell its prop-erty free of a tenant’s lease, Qualitech would have introduced a lease destruction technique previously unknown to leasehold mortgagees and their coun-sel. This is what many commentators feared, argu-ing that the decision should strike terror into the hearts of leasehold mortgagees everywhere. Professor Robert M. Zinman argued that Qualitech would create problems and risks “severe enough to result in serious problems for the future of leasehold financing and investment unless they are resolved now.” See Robert M. Zinman, Precision in Statutory Drafting: The Qualitech Quagmire and the Sad History of Section 365(h) of the Bankruptcy Code, 38 J. Marshall L. Rev. 97, 101 (2004). He urged Con-gress to enact legislation to address the problems arising from Qualitech in order to preserve real es-tate leasehold investments and prevent a massive flight from leasehold investment. One law firm’s Web site declared: “Beyond the questions it raises, the court’s opinion shows little recognition of its practical effect and commercial consequences. In the Seventh Circuit, tenants can be thrown out of the premises where they may be operating a vital portion of their business, even though they are performing under their leases, because of events in their landlord’s bankruptcy.”

(The comments no longer appear on the firm’s Web site, but a copy remains on file with the author.) In other words, according to these commenta-tors and many others, Qualitech represented a se-rious threat to tenants under ground leases, and hence their leasehold mortgagees. Five years later, has it turned out that such fears were well founded? Does the result in the Qualitech case really require remedial legislation? No. The Qualitech result appears to be unique, and subsequent cases (discussed below) have dem-onstrated that Qualitech has not opened the flood-gates to massive floods of lease terminations in landlords’ bankruptcy proceedings. Precision lost its lease primarily because it “sat on its rights.” It never bothered to object to Qual-itech’s section 363 sale of the leased property. The court effectively treated Precision’s silence as con-sent. If Precision had objected to the sale and tried to block it, the Bankruptcy Code would, without ques-tion, have supported Precision. That is because the Bankruptcy Code allows a landlord debtor to sell its property free and clear of a third party’s (e.g., Precision’s) “interest” in the property only if the particular interest meets one of five tests. The five tests are:1. State law allows the sale free of the interest;2. The holder of the interest consents;3. The interest is a lien securing an amount less

than the sale price;4. The interest is in bona fide dispute; or5. The holder of the interest could legally be com-

pelled to accept payment and release its lien.

Which of these five tests did Precision’s lease-hold meet (assuming the court properly treated it as an “interest” in Qualitech’s property, an assump-tion the author is willing to make)? Certainly not “1,” “3,” “4,” or “5.” The only remaining possibil-ity is “2”—the notion that Precision somehow con-


sented to Qualitech’s sale of the leased property free of Precision’s lease. The Seventh Circuit never actually stated which of the five tests Precision’s leasehold met. Instead, the court slid past the issue in a footnote: “[W]e shall assume, as [the new property owner] asserts, that one or more of the statutory criteria were met and that a sale of the property free and clear of Precision’s possessory interest as a lessee was per-missible.” 327 F.3d at 546 n.3. Based on Precision’s silence, this inference was perhaps (and perhaps not) reasonable. If Precision had unambiguously withheld con-sent to the section 363 sale and argued that Qual-itech as debtor had therefore satisfied none of the tests in section 363 to wipe out Precision’s “interest,” the outcome would almost certainly have changed and Precision might still occupy its warehouse. As noted above, some writers have called Qual-itech a disaster for leasehold lenders. This line of reasoning focuses on an issue of statutory interpre-tation that lies at the heart of the Qualitech case. Qualitech actually considered the interaction of two bankruptcy statutes. The first was section 363(f), which lets a debtor sell property free and clear of certain “interests,” as described above. Until Qual-itech, no one paid great attention to the possibility that a lease might constitute an “interest” that a debtor could terminate through a section 363 sale. Instead, in thinking about how a landlord might “get out from under” a burdensome lease by filing bankruptcy, everyone focused on Bankruptcy Code section 365(h), which allows a landlord to “reject” a lease. That section goes on to say, however, that a tenant can remain in possession under most of the terms of the “rejected” lease. As a result, unhappy landlords do not regard section 365(h) as a very at-tractive lease termination technique. In Qualitech, the District Court decided that sec-tions 363(f) and 365(h) conflicted, and resolved the conflict by concluding that a bankrupt landlord could proceed against a tenant only by rejecting the

lease under section 365(h) (not very helpful to the landlord). On appeal the Seventh Circuit reversed, concluding that if a bankrupt landlord satisfied any condition to holding a section 363 sale, then the landlord need not worry about section 365(h), and could treat a leasehold as an “interest” capable of being destroyed in a section 363 sale. The uproar that the Seventh Circuit created hardly seems justified. Precision lost primarily be-cause it “sat on its rights” under section 363(f), not because section 363(f) generally gives landlords a new technique to terminate leases. Precision failed to object to the sale, and therefore, in the words of the Seventh Circuit: “On August 13, 1999, at the conclusion of a noticed hearing, the bankruptcy court entered an order approving the sale (herein-after, the ‘Sale Order’). Precision, which had notice of the hearing, did not object to the Sale Order.” Id. at 540-41. Commentators have mostly focused on the statutory interpretation issue and have vehemently criticized the statutory interpretation in Qualitech. The dramatics do, however, seem overstated. Sub-sequent cases support that view. Even under the most debtor-oriented reading of the Qualitech case, a tenant (or presumably the leasehold lender in the tenant’s place) should still be able to prevent a bankrupt landlord from selling the leased premises free of the tenant’s lease—simply by standing up in court and objecting. Therefore, the leasehold mortgagee’s world should not come to an end. The entire problem in Qualitech was that Precision failed to exercise its statutory right to pro-tect itself. A 2005 bankruptcy court case involving a long-term ground lease supports this very limited inter-pretation of Qualitech. In In re Haskell L.P., 321 B.R. 1 (Bankr. D. Mass. 2005), Haskell owned an assisted living facility, part of which it rented to New Eng-land Baptist Hospital (“NEBH”) to operate a short-term stay facility under a 99-year lease. NEBH paid no rent, but did pay certain operating expens-


es and real estate taxes. Haskell, the landlord, filed for chapter 11 bankruptcy protection, and tried to terminate NEBH’s lease by selling the property un-der section 363 free and clear of all liens, claims, and “interests,” including the lease. For good mea-sure, Haskell, also filed a motion to reject the lease. Unlike the case in Qualitech, however, NEBH, the tenant, actively objected to Haskell’s motion to sell under section 363 free and clear of NEBH’s lease-hold interest. Haskell argued that it had the right to sell the property free and clear of NEBH’s lease because NEBH could be compelled to accept money in sat-isfaction of its claim under section 363(f)(5). NEBH disagreed, saying its interest could not be reduced to a money claim. Just as the Qualitech court had done, the Haskell court looked at the relationship between section 363 and section 365, finding that the lessee, NEBH, could “not be compelled to ac-cept money for its rejected lease under §363(f)(5) in view of the provisions of §365(h),” as doing so would eviscerate section 365(h). Id. at 9. The Haskell court also held that the lessee’s interest could not be adequately protected under section 365(h) un-less the lessee were permitted to retain possession under the lease. Thus, the court allowed NEBH to stay in place for the remainder of its lease term. To the extent that leasehold mortgagees still fear their investments after Qualitech, Haskell ought to dissipate any such fears. The latter case confirms the author’s view that a lessee can protect itself un-der section 363 merely by voicing its objection to the proposed sale of the leased premises. Two years later, another bankruptcy court de-cided In re Samaritan Alliance, LLC, 58 Collier Bankr. Cas. 2d (MB) 1635 (Bankr. E.D. Ky. Nov. 21, 2007), a case that should further reassure leasehold mort-gagees. Here the court again recognized the im-portance of allowing a lessee to object to a section 363 motion to sell free and clear, and decided to preserve the leasehold of a lessee that made such an objection.

In Samaritan Alliance, the debtor-sublandlord, Samaritan, leased a hospital from Ventas. Samari-tan then entered into various sublease agreements with a subtenant, Cardinal Hill. Soon after, Samar-itan filed for chapter 11 bankruptcy protection. The landlord and the debtor entered into vari-ous transactions that included a termination of the lease from Ventas to Samaritan and apparently culminated in Samaritan’s purported section 363 transfer of a new leasehold interest in the hospital “free and clear” to a new purchaser. Samaritan nev-er bothered to tell Cardinal Hill about the resulting termination of its sublease. Cardinal Hill objected. The court, explicitly following Haskell, held that the purchaser did not buy Samaritan’s leasehold free and clear of Cardinal’s subtenancy because, as the Haskell court had ruled, section 365(h) preserved Cardinal Hill’s possessory interests, and nothing in section 363 allowed the termination of those interests. Thus, the court allowed Cardinal Hill to remain in its subleased space for the rest of the sub-lease term. A third decision demonstrated that the courts know how to apply section 363 without destroy-ing the legitimate expectations of ground lessees and their lenders. In S. Motor Co. v. Carter-Pritchett-Hodges, Inc. (In re MMH Auto. Group, LLC), 385 B.R. 347 (Bankr. S.D. Fla. 2008), RGA leased space for a billboard to CPH for 99 years in exchange for a single up-front payment of $15,000. RGA then sold the property to MMH, subject to the billboard lease. MMH filed for chapter 7 bank-ruptcy protection, but did not include the billboard lease on its schedule of executory contracts. There-fore, the trustee did not file a motion to assume or reject it. The property was sold in a court-approved sale under section 363 to the purchaser free and clear of all claims, liens, and encumbrances. When the purchaser learned that the billboard lease ex-isted, it sought to have the sale order enforced and to obtain a declaration that CPH had no interest in the property.


The court first found that CPH had not re-ceived the notice to which it was statutorily entitled. If CPH had received such notice and objected, the court said, both sections 363(f) and 365(h) would have applied. As a result, the trustee could not have sold the property free and clear of the billboard lease unless one of the section 363(f) conditions were met. Because the billboard lease expressly provided for a valuation and liquidated buy-out of CPH’s lease-hold interest, the court found that CPH could be compelled to accept a money satisfaction of its in-terest as contemplated under section 363(f)(5). Thus, this was a case where section 363 would have allowed the debtor-landlord to have sold the property free and clear of the leasehold—as an “interest” whose holder could have been forced to accept a monetary payment in substitution for its interest. But, because CPH’s interest would have been protected by receiving payment of the valu-ation amount contemplated by the lease itself, the court confirmed the sale and ordered that CPH re-ceive the liquidated value of its interest from the sale proceeds. The MMH Automotive decision again shows that the fears that Qualitech might destroy lenders’ in-vestments through section 363 sales are unfound-ed. Not only will a court respect a tenant’s interests upon actual objection, but it will assume that if a tenant were given appropriate notice of an attempt to sell free and clear of any interests, the tenant would file an objection to such a sale and request protection of its leasehold interest. And the case also demonstrates that the use of section 363 may be a perfectly appropriate mechanism to terminate a lease when the lease by its terms allows termi-nation upon payment of a liquidated amount—precisely a category of “interest” that section 363 allows to be terminated. The termination of the billboard lease through a section 363 sale in MMH Automotive hardly seems shocking. In another bankruptcy case, the court inter-preted section 363(f) to extinguish any interests the

tenant held, including the tenant’s rights under sec-tion 365(h). The case includes no factual history that would shed light on the context or the court’s conclusion. The case does seem to suggest that—as in Qualitech—the tenant never objected or sought to have her interests protected. Still, the commenta-tors who feared terrible consequences from Qual-itech might point to this particular case as an ex-ample. See In re Sophie H. Ng, 2007 Bankr. LEXIS 4212 (Bankr. N.D. Cal. Dec. 13, 2007). The push for legislation to clarify the distinc-tion between sections 363 and 365, urged by many commentators and supported by the American Bar Association, has thus proven unnecessary, and has indeed gone nowhere. See Christopher C. Geno-vese, Precision Industries v. Qualitech Steel: Easing the Tension Between Sections 363 and 365 of the Bankruptcy Code?, 39 Real Prop. Prob. & Tr.. J. 627, 649 (2004) (“This clear division among authorities [regarding the proper application of sections 363 and 365] demonstrates the need for Congress to intervene and provide guidance about what it desires as a result”); Zinman, supra; Letter from ABA to Con-gress, supra. The fact that Congress has tabled the proposed legislation leaves leasehold mortgagees with the cases discussed in this article. Those cases demonstrate that when a tenant does object to a section 363 sale, the courts seem eminently capable of applying section 363 in a sensible way, without destroying the legitimate expectations of tenants and their leasehold mortgagees. Again, all a tenant must do to protect its interests is object. It is now evident that the holding in Qualitech was nothing more than a direct result of the tenant’s failure to object. It turns out that, after all, the sky did not fall on leasehold mortgagees. Even though these cases suggest the fears about Qualitech were overstated, a leasehold mortgagee should think about section 363 in its loan docu-ments. What lessons can tomorrow’s leasehold mortgagees learn from the Qualitech case?


Most leasehold mortgage documents already require that the tenant/borrower preserve its lease-hold. That obligation should include an obligation for the tenant/borrower to object vociferously (not in those words exactly) if the landlord wants to de-stroy the lease through a section 363 sale. Typical leasehold mortgage documents also usually let a leasehold mortgagee take any steps necessary to protect its collateral. This should in-clude the right to try to stop the landlord from ter-minating the lease through a section 363 sale. The leasehold lender may want a nonexclusive agency appointment toward that end. For new transactions, Qualitech may lead lease-hold lenders and their counsel to add some new lan-guage to their loan documents to say the borrower/tenant really shouldn’t let the landlord destroy the lease through a section 363 sale, and the lender can stand up and object to such a sale. A leasehold lend-er may also want to see corresponding language in the ground lease itself. Others have suggested add-ing language to confirm that the tenant cannot be compelled to accept a monetary payment in place of its leasehold. Any such statement would amount to a pre-emptive defense against another possible theory (suggested and rejected in the Haskell case) by which a landlord might try to use section 363(f) to terminate leases. But this particular acknowledg-ment seems fairly self-evident—no more necessary or appropriate than adding a statement that the lease is not a giraffe or a chimpanzee.

Any new lease verbiage of any of the types just

suggested should be perfectly noncontroversial and

routine. It should solve whatever problems Qualitech

caused, if existing language and existing law did

not already.

Looking forward, for both new and old transac-

tions, ground tenants and leasehold lenders should

pay attention to their ground leases. This repre-

sents no great new insight. If a tenant or leasehold

lender receives notice of the landlord’s bankruptcy

and the landlord’s desire to sell the leased property

under section 363, the tenant and leasehold lender

should do something about it and object if neces-

sary. (One would think that the lender should have a

constitutional right to notice of any proposed sale.)

If Precision had done exactly that, Qualitech would

never have taught leasehold mortgagees about new

bankruptcy risks over which to lose sleep.

Ultimately, Qualitech stands for just three prin-

ciples, none justifying the hysteria the case gener-

ated:

Anyone who holds an interest in real estate •

must monitor its position and act proactively to

protect that position when necessary;

Not only do bad facts produce bad law, but bad •

law based on bad facts produces ever-longer

documents; and

Surprises never end in the world of ground •

leases.

To purchase the online version of this article, go to www.ali-aba.org.

http://www.ali-aba.org

How Much Protection Does ALeasehold Mortgagee Need?

Joshua Stein

In this article, the author presents and explains a set of ‘‘middle ground’’

leasehold mortgagee protections that try to balance the concerns of the landlord

and the leasehold mortgagee in a simple and straightforward way.

Every real estate developer, investor, or attorney whonegotiates a long-term ground lease (a ‘‘Lease’’)1

knows that the Lease must be ‘‘�nanceable.’’ Thismeans the Lease must contain certain provisions (the‘‘Leasehold Mortgagee Protections’’) to protect theinterests of a likely future Leasehold Mortgagee.

Those interests boil down to assuring that LeaseholdMortgagee can always: (a) take and readily enforce aLeasehold Mortgage; (b) preserve the Lease and itsvalue, even if the transaction goes into default orsurprises occur; or (c) abandon a bad investment.2

To achieve these goals, Tenant and its counselmight say a Lease should contain: (a) every possibleLeasehold Mortgagee Protection any real estate lawyerhas ever devised; (b) absolute clarity and full detailabout every single element of every single one of thoseLeasehold Mortgagee Protections, leaving nothing tobe resolved later and no possible hypothetical sequenceor con�uence of events unaddressed; and perhaps (c)as many words and pages as possible devoted toprotecting Leasehold Mortgagee. Such an approach, if

carefully and intelligently implemented, may minimizethe possibility that any particular prospective Lease-hold Mortgagee or its counsel ever will �nd a substan-tive basis to disapprove a Lease. It can, however, leadto complexity, verbiage, negotiations, and risk oferror.3

At the opposite extreme, Tenant and its counselmight say a Lease should contain only the bare mini-mum Leasehold Mortgagee Protections necessary tosatisfy the literal requirements and expectations of therating agencies. The Lease would simply parrot theexpress requirements of the rating agencies (just thewords in their published ground lease criteria), so thatin any securitization the Lease should match up to thepublished words and pass without objection. This ap-proach keeps everything simple and avoids problems.

‘‘Minimal’’ Leasehold Mortgage Protections willwork, though, only if: (a) Landlord and its counseldon't try to festoon those ‘‘minimal’’ LeaseholdMortgagee Protections with too many conditions, limi-tations, procedures, quali�cations, requirements,restrictions, and so on; and (b) no future prospective‘‘B-piece’’ buyer, Leasehold Mortgagee, participant,purchaser, rating agency, or syndicate member everdecides it wants the Lease to contain more than thebare minimum Leasehold Mortgagee Protections asthe rating agencies had publicly de�ned them when theparties negotiated their Lease.4

The author has previously published LeaseholdMortgagee Protections at both the ‘‘minimum’’ and‘‘maximum’’ extremes suggested above.5 In responseto reactions from readers, the author has now prepareda ‘‘middle ground’’ set of Leasehold Mortgagee Pro-tections, which is presented here, after these introduc-

Joshua Stein ([email protected]) is a real estate and�nance partner with Latham & Watkins LLP. He is a memberof the American College of Real Estate Lawyers; Secretaryof the New York State Bar Real Property Law Section; andauthor of New York Commercial Mortgage Transactions(Aspen 2002), A Practical Guide to Real Estate Practice(ALI-ABA 2001), and over 100 articles, outlines, and othermaterials about commercial real estate transactions. Someof his articles are reprinted at www.real-estate-law.com.The author acknowledges the contributions of his partnersRichard L. Chadako� and James I. Hisiger, and of the fol-lowing other individuals: Arthur S. Adler, Sullivan & Crom-well; Hugh P. Finnegan, Siller Wilk LLP; Gary A. Goodman,Sonnenschein Nath & Rosenthal; Andrew L. Herz, BinghamMcCutchen LLP; Donald H. Oppenheim, Meyers Nave PC;and Benjamin Suckewer, Fischbein Badillo Wagner Harding.

THE REAL ESTATE FINANCE JOURNAL/SPRING 2003 5

tory comments. These ‘‘middle ground’’ LeaseholdMortgagee Protections seek to give Tenant and Lease-hold Mortgagee a reasonably succinct, simple, straight-forward, ‘‘fair,’’ and almost always adequate way toaddress each of the usual, typical, and standard con-cerns of a generic Leasehold Mortgagee.

These Leasehold Mortgagee Protections omit manyof the following items that often in�ate and complicateany Leasehold Mortgagee Protections:

E Options. ‘‘Bells and whistles’’ for unusual ornonstandard structures.

E Negotiations. Landlord-oriented concessions orquali�cations, beyond the bare minimum neces-sary to prevent laughter by Landlord's counsel.

E Details. Detailed procedures, time limits, noticerequirements, and the like.

E More Details. Extreme levels of clarity, speci�c-ity, and completeness.

Even without these elements, the ‘‘middle ground’’Leasehold Mortgagee Protections o�ered here shouldcover every �nanceability issue adequately and makeany Lease �nanceable in the eyes of any reasonableLeasehold Mortgagee.6 Of course, if a transactionneeds ‘‘bells and whistles,’’ these ‘‘middle ground’’Leasehold Mortgagee Protections will not providethem. The author's previously published ‘‘maximum’’Leasehold Mortgagee Protections can help �ll that gap.

By leaving out some details, these ‘‘middle ground’’Leasehold Mortgagee Protections increase the risk ofglitches, uncertainty, and surprises. That may, in turn,increase the risk of litigation if: (a) some unusual left-�eld circumstance or sequence of events occurs; (b)the Leasehold Mortgagee Protections do not address itperfectly; and (c) the parties cannot resolve it in a rea-sonable way. In general, though, the details omittedfrom these Leasehold Mortgagee Protections relateonly to very hypothetical and unlikely events. More-over, in the real world, parties can and do virtuallyalways negotiate a reasonable resolution for most un-expected problems that might arise, assuming each hasreasonable leverage, although the process can be pain-ful and expensive.

These Model Leasehold Mortgagee Protectionsomit a few provisions that sometimes appear in Lease-hold Mortgagee Protections. Each such omissionre�ects a judgment that the particular provision either:(a) represents excessive detail; (b) imposes a burdenon Landlord that is both unreasonable and unneces-sary; (c) is highly unlikely ever to become relevant,and can be dealt with in some other reasonable way ifit ever does become relevant; or (d) otherwise does notneed to be covered.

In addition to looking for ‘‘pure’’ Leasehold Mort-gagee Protections, which serve Leasehold Mortgagee'sinterests without directly serving Tenant's, any Lease-hold Mortgagee evaluating a Lease as possible collat-eral for a loan will also care about all the other terms

of the Lease—everything that makes the Lease a valu-able asset. That analysis forces Leasehold Mortgageeto consider nearly every issue that can arise in a Lease.Nearly every such issue, if handled badly enough, canmake a Lease ‘‘un�nanceable.’’

To try to cover all these issues in a discussion ofLeasehold Mortgagee Protections could turn the dis-cussion into a general discussion of ground leases,which is not the goal here. Nevertheless, Tenant andLeasehold Mortgagee share a few very fundamentalconcerns. The issues on that ‘‘short list’’ are commonlyregarded as Leasehold Mortgagee Protections eventhough they are not unique to Leasehold Mortgagees.The following ‘‘medium’’ Leasehold Mortgagee Pro-tections cover a few of those fundamental ‘‘shared is-sues’’7 before turning to issues of concern primarily toLeasehold Mortgagees.

The numbered comments at the end of this article(the ‘‘endnotes’’) describe some judgment calls, be-yond mere omissions, that these Leasehold MortgageeProtections re�ect. Anyone can always argue for someother judgment call. That is inevitable once one tries toidentify a ‘‘middle ground’’ approach to a document.Similarly, anyone might deem any omitted issue to beworth covering.8

Because of their substantive nature, the endnotesare an important part of this article, which should beconsidered by anyone reading this article.

In addition to de�ning a ‘‘reasonable’’ set of Lease-hold Mortgagee Protections, the following model seeksto demonstrate straightforward, simple, and compre-hensible legal writing, consistent with the author'spublished pleas for use of Plain English even in so-phisticated commercial real estate transactionaldocuments.9 The author tries to prove in this documentthat attorneys can write substantial legal documents inreadable English that nonlawyers can readilyunderstand. Legal documents don't need to be writtenin some weird and perverted form of quasi-English,marked by long sentences, convoluted verb structures,the passive voice, redundancy, and gratuitouscomplexity.10

The author welcomes comments on these LeaseholdMortgagee Protections, both substantive and stylistic.

De�nitions

‘‘Bankruptcy Termination Option’’ means Tenant'sright to treat this Lease as terminated under 11U.S.C.A. § 365(h)(1)(A)(i) or any comparable provi-sion of law.

‘‘Fee Estate’’ means Landlord's fee interest in thePremises,11 including12 Landlord's reversionary inter-est, all subject to this Lease.

‘‘Foreclosure Event’’ means any: (a) foreclosuresale, trustee's sale, assignment of this Lease in lieu offoreclosure, sale under 11 U.S.C.A. § 363, or similartransfer a�ecting this Lease or (b) Leasehold Mortgag-

How Much Protection Does A Leasehold Mortgagee Need?

6 THE REAL ESTATE FINANCE JOURNAL/SPRING 2003

ee's exercise of any other right or remedy under aLeasehold Mortgage or applicable law as a result ofwhich Tenant is divested of its interest in this Lease.

‘‘Incurable Tenant Default’’ means any TenantDefault that Leasehold Mortgagee or New Tenant can-not reasonably cure.

‘‘Lease Impairment’’ means Tenant's: (a) cancel-ing, modifying,13 surrendering, or terminating thisLease, including upon a Loss; (b) waiving any term ofthis Lease; (c) subordinating this Lease to any otherestate or interest in the Premises; or (d) exercising aBankruptcy Termination Option.

‘‘Lease Termination Notice’’ means a notice stat-ing that this Lease has terminated, and describing inreasonable detail all uncured Tenant Defaults.

‘‘Leased Fee Value’’ means the fair market valueof the Fee Estate, considered as if it were unimproved14

and subject to this Lease.15

‘‘Leasehold Mortgage’’ means a mortgage, deed oftrust, collateral assignment, or other lien (as modi�edfrom time to time) encumbering this Lease and Ten-ant's rights under this Lease, including Tenant'sleasehold interest and Preemptive Rights.16

‘‘Leasehold Mortgagee’’ means a holder of a Lease-hold Mortgage and its successors and assigns, providedthat: (a) it is not an A�liate of Tenant; and (y) Landlordhas received notice of its name and address and a copyof its Leasehold Mortgage.17

‘‘Loss’’ means a casualty or condemnation a�ect-ing the Premises.

‘‘Loss Proceeds’’ means any insurance proceeds orcondemnation award paid or payable for a Loss.

‘‘New Lease’’ means a new lease of the Premises(as amended from time to time in compliance with itsterms) and related customary documents such as amemorandum of lease and a deed of improvements.Any New Lease shall: (a) be on the same terms, includ-ing Preemptive Rights, and have the same priority, asthis Lease; (b) commence immediately after this Leasehas terminated; (c) continue for the entire remainingterm of this Lease, as it existed before termination,subject to Preemptive Rights; (d) give New Tenant thesame rights to improvements that Tenant had underthis Lease; and (e) require New Tenant to cure, withreasonable diligence and continuity, and within a rea-sonable time, all Tenant Defaults (except IncurableTenant Defaults) not previously cured or waived.

‘‘New Tenant’’ means Leasehold Mortgagee or itsdesignee or nominee, and any of their successors andassigns.

‘‘Preemptive Right’’ means any renewal, expan-sion, or purchase option; right of �rst refusal or �rst of-fer; or other preemptive right this Lease gives Tenant.

‘‘Remaining Premises’’ means any Premises thatLandlord continues to own after a Total Loss.

‘‘Tenant Default’’ means any default or breach byTenant under this Lease.

‘‘Tenant Default Notice’’ means Landlord's noticeof a Tenant Default, which notice shall describe suchTenant Default in reasonable detail.

‘‘Termination Option Loss’’ means any Loss thatoccurs during the last �� months of the Term orwould cost more than $�� (beyond available LossProceeds) to restore.

‘‘Total Loss’’ means any: (a) condemnation that af-fects all or substantially all the Premises; (b) partialcondemnation after which Tenant cannot reasonablyrestore the remaining Premises for use for its previouspurpose; or (c) casualty after which, because ofchanges in law, Tenant cannot legally restore thePremises for use for its previous purpose. Tenant, act-ing reasonably, shall determine whether a ‘‘TotalLoss’’ has occurred under clause ‘‘b’’ or clause ‘‘c,’’but Tenant's determination that such a ‘‘Total Loss’’has occurred shall not be e�ective without LeaseholdMortgagee's consent.

Use

Tenant may use the Premises for any lawful purpose.18

Assignment

Tenant may, without Landlord's consent, at any timeassign this Lease provided that Tenant or the assigneegives Landlord a copy of the assignment documentsand also, except in the case of an assignment through aForeclosure Event or a collateral assignment to aLeasehold Mortgagee, Tenant: (a) has achieved Sub-stantial Completion of Development; and (b) causesthe assignee to deliver to Landlord an assumption ofthis Lease.

Subleases

Tenant may, without Landlord's consent, sublease thePremises in whole or in part. If this Lease terminates,Landlord shall not disturb the possession, interest, orquiet enjoyment of any Subtenant not in default be-yond applicable cure periods under its Sublease,provided that either: (a) such Sublease demises theentire Premises and is in all material respects at alltimes no less favorable to Landlord than this Lease; or(b) all the following conditions have been satis�ed: (1)Subtenant is unrelated to Tenant; (2) the Sublease wason commercially reasonable and fair market termswhen Subtenant became legally bound;19 and (3) atleast one Leasehold Mortgagee has agreed to grantSubtenant nondisturbance protection.20

Loss21

If a Loss occurs: (a) the party that �rst becomes awareof it shall notify the other party; (b) the parties shalldirect the payor to pay all Loss Proceeds to LeaseholdMortgagee;22 (c) Loss Proceeds shall be applied as fol-


lows until exhausted; (d) each party's rights to receiveLoss Proceeds shall be subject to the rights of suchparty's mortgagee(s); and (e) the parties shall have thefollowing rights and obligations.23

Landlord's Costs. First, Landlord shall receive LossProceeds su�cient to reimburse Landlord and FeeMortgagee for their reasonable costs and expenses,including reasonable attorneys' fees and expenses,incurred because of the Loss.24

Total Loss. Second, if a Total Loss occurs, thisLease shall terminate. Landlord shall receive LossProceeds equal to the Leased Fee Value as if the TotalLoss had not occurred. If, after the Total Loss, anyRemaining Premises exist, then: (a) Landlord mayrequire Tenant to remove from the Remaining Premisesall debris resulting from the Total Loss, �ll in anysubstantial excavations in the Remaining Premises, andreturn the Remaining Premises to a level and vacantcondition; and (b) Landlord's share of Loss Proceedsshall be reduced by the value of the RemainingPremises. Tenant shall then receive all remaining LossProceeds.25

Termination Option Loss. Third, if a TerminationOption Loss occurs, Tenant may (subject to the provi-sions of this Lease on Lease Impairments) terminatethis Lease by notice to Landlord.26 Upon such a termi-nation, Landlord shall receive all Loss Proceeds.27

Rent Adjustment. Fourth, in the event of any con-demnation of the Premises, except a temporary con-demnation or a Total Loss: (a) future Rent under thisLease shall be reduced by the product of such futureRent (as it would have been determined but for thecondemnation) times the percentage of the Premisestaken, by value; and (b) Landlord shall receive LossProceeds equal to the diminution in the Leased FeeValue resulting from such condemnation, taking intoaccount the foregoing reduction in Rent and the e�ectof the condemnation on the value of Landlord'sreversion.

Restoration. Fifth, if this Lease does not terminatebecause of a Loss, Tenant shall apply Loss Proceeds toremove all debris remaining from the Loss and torestore the Improvements substantially as they existedbefore the Loss (subject to changes that this Leasewould otherwise allow Tenant to make), to the extentreasonably possible under the circumstances.28 Tenantshall then receive any remaining Loss Proceeds.

Disbursement. To the extent that this Lease requiresTenant to apply Loss Proceeds for a speci�ed purpose,Loss Proceeds shall be: (a) disbursed from time to timeunder reasonable and customary disbursement proce-dures in Leasehold Mortgagee's loan documents (or,absent such procedures, disbursement procedures asLandlord reasonably determines); and (b) released toTenant, to the extent remaining, only if and when Ten-ant has accomplished that purpose.

Fee Mortgages29

Every Fee Mortgage shall be, and shall state that it is,

subject and subordinate to this Lease and any NewLease.30 Any Leasehold Mortgage shall attach solelyto Tenant's leasehold estate under this Lease. AnyForeclosure Event under a Leasehold Mortgage shall:(a) transfer only Tenant's interest in this Lease; and (b)not impair any estate or rights under any FeeMortgage.31

Leasehold Mortgages

Without Landlord's consent, from to time, but subjectto all other terms of this Lease not inconsistent withthis paragraph: (a) provided that any Event of Defaulthas been, or simultaneously is, cured, Tenant may grantLeasehold Mortgage(s);32 (b) Leasehold Mortgageemay initiate and complete any Foreclosure Event; and(c) any transferee through a Foreclosure Event, and itssuccessors and assigns, may assign this Lease.

Lease Impairments

Any Lease Impairment made without Leasehold Mort-gagee's consent shall be null, void, and of no force ore�ect, and not bind Leasehold Mortgagee or NewTenant.33

Notices

No notice that Landlord gives Tenant shall be e�ectiveunless Landlord has given a copy of it to LeaseholdMortgagee. If any Tenant Default occurs for whichLandlord intends to exercise any remedies, Landlordshall promptly give Leasehold Mortgagee a TenantDefault Notice.

Opportunity to Cure

Landlord shall accept Leasehold Mortgagee's cure ofany Tenant Default34 at any time until �� days35 af-ter both: (a) Tenant and Leasehold Mortgagee havereceived the Tenant Default Notice; and (b) Tenant'scure period for the Tenant Default has expired. IfLeasehold Mortgagee cannot reasonably cure the Ten-ant Default within such period, Leasehold Mortgageeshall have such further time as it shall reasonably needso long as it proceeds with reasonable diligence. IfLeasehold Mortgagee cannot reasonably cure a TenantDefault without possession of the Premises, or in theevent of an Incurable Tenant Default, LeaseholdMortgagee shall be entitled to such additional time asit shall reasonably need to consummate a ForeclosureEvent and obtain such possession, provided LeaseholdMortgagee timely exercises its cure rights for all otherTenant Defaults. If Leasehold Mortgagee consum-mates a Foreclosure Event, Landlord shall waive allIncurable Tenant Defaults.

Cure Rights Implementation

At any time when Leasehold Mortgagee's cure rights



have not expired, Landlord shall do nothing to termi-nate this Lease or accelerate any rent, or otherwiseinterfere with Tenant's or Leasehold Mortgagee's pos-session and quiet enjoyment of the Premises. LeaseholdMortgagee may at its option enter the Premises to seekto cure a Tenant Default. This right or its exercise shallnot be deemed to give Leasehold Mortgagee posses-sion of the Premises. Leasehold Mortgagee need notcure any Tenant Default arising from any lien orencumbrance that attaches solely to this Lease (and notto the Fee Estate) but is junior to its Leasehold Mort-gage, provided that Leasehold Mortgagee endeavorswith reasonable diligence to consummate a Foreclo-sure Event.

New Lease

If this Lease terminates for any reason (except withLeasehold Mortgagee's consent or because of a TotalLoss), even if Leasehold Mortgagee failed to timelyexercise its cure rights for a Tenant Default,36 thenLandlord shall promptly give Leasehold Mortgagee aLease Termination Notice. Upon Leasehold Mortgag-ee's request, Landlord shall enter into a New Leasewith New Tenant. Any such request must be made, ifat all, at any time before the day that is �� days afterLeasehold Mortgagee has received Landlord's LeaseTermination Notice. Landlord's obligation to enter intoa New Lease shall be subject to the conditions that NewTenant shall (in accordance with the Lease Termina-tion Notice): (a) cure all remaining uncured TenantDefaults that New Tenant can then reasonably cure;and (b) pay Landlord's reasonable costs and expenses(including reasonable attorneys' fees and expenses) interminating this Lease, recovering the Premises, andentering into the New Lease.37 New Tenant need notcure any Incurable Tenant Default.

New Lease Implementation

If Leasehold Mortgagee timely requests a New Leasein conformity with the conditions and requirements ofthis Lease, then from termination of this Lease untilexecution and delivery of a New Lease: (a) New Ten-ant shall be entitled to all net income of the Premises;and (b) Landlord shall not terminate any Subleasesexcept for Subtenant's default, or enter into any leasea�ecting any of the Premises except with New Tenant.When the parties sign a New Lease, Landlord shall co-operate with New Tenant to transfer to New Tenant allSubleases (including any security deposits Landlordheld), service contracts, and operations of thePremises.38 Landlord shall cause every Fee Mortgageeto unconditionally subordinate to any New Lease.

Tenant's Rights Under Lease

If this Lease contains any Preemptive Right and Ten-ant does not timely exercise it when this Lease allows,

Landlord shall promptly notify Leasehold Mortgagee.Until �� days after Leasehold Mortgagee has re-ceived such notice, Leasehold Mortgagee may exercisethe Preemptive Right for Tenant. Leasehold Mortgageemay exercise any or all of Tenant's rights (includingPreemptive Rights) under this Lease.39 So long asLeasehold Mortgagee's cure rights under this Leasehave not expired, Leasehold Mortgagee may exerciseany such rights even if Tenant is in default under thisLease, notwithstanding anything to the contrary in thisLease. Tenant irrevocably assigns to Leasehold Mort-gagee,40 to the exclusion of Tenant and any otherperson, any right to exercise any Bankruptcy Termina-tion Option.41

Certain Proceedings

If Landlord or Tenant initiates any appraisal, arbitra-tion, litigation, or other dispute resolution proceedinga�ecting this Lease, then the parties shall simulta-neously notify Leasehold Mortgagee. Leasehold Mort-gagee may participate in such proceedings on Tenant'sbehalf, or exercise any or all of Tenant's rights in suchproceedings. At Leasehold Mortgagee's option, anyactions of Leasehold Mortgagee under the precedingsentence shall be to the exclusion of Tenant.42 Anysettlement shall not be e�ective without LeaseholdMortgagee's consent.43

No Merger

If this Lease and the Fee Estate are ever commonlyheld, they shall remain separate and distinct estates(and not merge) without consent by Leasehold Mort-gagee and Fee Mortgagee.

No Personal Liability

No Leasehold Mortgagee or New Tenant shall haveany liability under this Lease beyond its interest in thisLease, even if it becomes Tenant. Any such liabilityshall: (a) not extend to any Tenant Defaults that oc-curred before such Tenant took title to this Lease (or aNew Lease), except any identi�ed in a Tenant DefaultNotice or Lease Termination Notice; and (b) terminateif and when any such Tenant assigns (and the assigneeassumes) or abandons this Lease (or a New Lease).

Multiple Leasehold Mortgagees44

If at any time multiple Leasehold Mortgagees exist: (a)any consent by or notice to Leasehold Mortgagee refersto all Leasehold Mortgagees; (b) except under clause‘‘a,’’ the most senior Leasehold Mortgagee may exer-cise all rights of Leasehold Mortgagee(s), to the exclu-sion of junior Leasehold Mortgagee(s); (c) to the extentthat the most senior Leasehold Mortgagee declines todo so, any one other Leasehold Mortgagee may exer-cise those rights, in order of priority;45 and (d) if


Leasehold Mortgagees do not agree on priorities, awritten determination of priority issued by a title insur-ance company licensed in the State shall govern.

Further Assurances

Upon request from Tenant or any Leasehold Mortgagee(prospective or current), Landlord shall promptly andin writing, under documentation reasonably satisfac-tory to Landlord and the requesting party: (a) certifythat this Lease is in full force and e�ect, whether it issubject to any Lease Impairment, that to Landlord'sknowledge no Tenant Default exists, the date throughwhich Rent has been paid, and such other similar mat-ters as may be reasonably requested, all subject to anythen exceptions reasonably speci�ed in such certi�-cate; (b) agree directly with Leasehold Mortgagee thatit may exercise against Landlord all of LeaseholdMortgagee's rights under this Lease; (c) acknowledgeany Subtenant's nondisturbance and recognition rights(provided Subtenant joins in such agreement); and (d)provided that Tenant reimburses Landlord's reason-able attorneys' fees and expenses, enter into any Leasemodi�cation that any current or prospective LeaseholdMortgagee requests, if it does not adversely a�ectLandlord in any material respect or reduce any pay-ment this Lease requires.

Miscellaneous

Notwithstanding anything to the contrary in this Lease,Leasehold Mortgagee: (a) may exercise its rightsthrough an a�liate, assignee, designee, nominee, sub-sidiary, or other Person, acting in its own name or inLeasehold Mortgagee's name (and anyone so actingshall automatically have the same protections, rights,and limitations of liability as Leasehold Mortgagee);(b) shall never be obligated to cure any Tenant Default;(c) may abandon such cure at any time;46 and (d) maywithhold its consent or approval for any reason or noreason, except where this Lease states otherwise. Anysuch consent or approval must be written. To the extentany Mortgagee's rights under this Lease apply afterthis Lease terminates, they shall survive.

1 The sample Leasehold Mortgagee Protections belowde�ne many capitalized terms. Obvious de�nitions of othercapitalized terms are omitted. ‘‘Lease’’ should include anyamendments made in compliance with the Lease.

2 Tenant does not directly share the special concerns of aLeasehold Mortgagee—at least if Tenant knows with abso-lute certainty that it, and its successors and assigns, will neverneed a Leasehold Mortgage. A more typical Tenant will, ofcourse, care a great deal about Leasehold MortgageeProtections. They make a Lease �nanceable and hence morevaluable to a broader universe of future debt and equityinvestors.

3 It also causes headaches, according to counsel for atleast one Landlord.

4 The rating agencies' published standards do not alwaystrack their current practices.

5 See Joshua Stein, ‘‘Model Leasehold Mortgagee Protec-tions,’’ The American College of Real Estate Lawyers Pa-pers, October 1999; updated and republished for ChicagoTitle Insurance Company continuing legal education program(2000), Association of the Bar of the City of New York(2000), New York State Bar Association Real Property LawSection (2000); New York State Bar Association Real Prop-erty Law Section, Advanced Real Estate Practice, 2000; andNew York Mortgage Bankers Association (2001). Except the1999 publication, each of the foregoing included both the‘‘maximum’’ and the ‘‘minimum’’ Leasehold MortgageeProtections. Both are periodically updated. Current versionsmay be obtained from the author.

6 This is not a representation or warranty. Any prospec-tive Leasehold Mortgagee's counsel can, if it wishes, almostalways �nd some basis to disapprove any Lease.

7 Beyond the ‘‘shared issues’’ covered here, a LeaseholdMortgagee would also look �rst at the following issues:remaining term, transferability, rent adjustment (includingparticularly the absolute clarity of any revaluation formula),unusual obligations, alterations, demolition, insurance, andenvironmental matters.

8 Anything these Leasehold Mortgagee Protections omitis generally covered, often at length, in the author's previ-ously published ‘‘maximum’’ Leasehold MortgageeProtections.

9 See Joshua Stein, ‘‘Writing Clearly and E�ectively:How to Keep the Reader's Attention,’’ New York State BarAssociation Journal, July/August 1999, at 44; SecuredLender, November/December 1999; ‘‘Template for a Tem-plate: A Checklist To Prepare or Improve Any Model Docu-ment,’’ The Practical Lawyer, April 2000, at 15; reprinted inReal World Document Drafting: Form, Style, and Substance(ALI-ABA professional skills course materials), December2001, at 131; April 2002, at 151; ‘‘How to Use De�nedTerms to Make Transactional Documents Work Better,’’ ThePractical Lawyer, October 1997, at 15, republished in ALI-ABA's Practice Checklist Manual on Advising BusinessClients II: Checklists, Forms, and Advice from The PracticalLawyer, 2000; and ‘‘Cures for the (Sometimes) NeedlessComplexity of Real Estate Documents,’’ Real Estate Review,Fall 1995, at 63.

10 In ‘‘Short and Simple,’’ The American Lawyer, October2002, at 59, the author suggested these seven principles forbetter legal writing. (1) Break long sentences into shorterones. (2) Get rid of words, sentences, and paragraphs you donot need. (3) Prefer verbs to nouns. (4) Question any use of aword that includes ‘‘here’’; try to substitute something lesslegalistic. (5) Use simple words if you can. (6) Use the activevoice. (7) Write larger numbers as numerals. These principlesare hardly new, unique, or previously undiscovered. See, e.g.,William Strunk, Jr. & E.B. White, The Elements of Style (4thed. 2000). Even so, the legal profession remains largelyoblivious to them. The author has tried to apply them consis-tently in these Leasehold Mortgagee Protections.

11 ‘‘Premises’’ should include appurtenant air rights anddevelopment rights.

12 The Lease should say somewhere, once, that ‘‘include’’means ‘‘without limitation.’’

13 ‘‘Modi�cation’’ seems synonymous with ‘‘amend-



ment’’ or ‘‘change,’’ both of which one also often expects tosee, redundantly, in any de�nition like this one.

14 This assumes the Lease originally demised raw land.The valuation of Landlord's leased fee estate raises many is-sues, including nuances such as how to deal with downzon-ing or upzoning since the Commencement Date.

15 For this and other value-related provisions, the Leaseshould set appraisal procedures.

16 Mezzanine lenders may want protections like those ofLeasehold Mortgagee, but this language does not providethem. Landlord may argue that a mezzanine lender is ef-fectively an equity investor and should rely on its rights as anequity investor rather than bother Landlord. Landlord maywant to limit the amount, purpose, or type of loan(s) thatLeasehold Mortgages secure. For long-term ground leases,such limitations are generally not market standard or ap-propriate, at least after Tenant has completed initialconstruction/development. Once Tenant has reached thatpoint: (a) any Leasehold Mortgage of any size to any Lease-hold Mortgagee merely creates a possible future ForeclosureEvent and a possible future Lease transfer; (b) Landlordshould not care; and (c) even if overleverage creates sometheoretical possibility of slightly impairing or temporarilydeferring Landlord's rental income, Landlord's concerns arenot compelling. Tenant will usually agree that LeaseholdMortgagee must: (1) be ‘‘institutional’’; (2) have a minimumnet worth; and (3) meet other objective and reasonablecriteria. These concessions will cause de�nitional issues,complexity, and risk of obsolescence.

17 Landlord may also want copies of: (a) the unrecordedloan documents; and (b) future amendments. Neither requestseems justi�ed.

18 Leasehold Mortgagee will usually tolerate a somewhatnarrower permitted use. Some argue that the breadth of theuse clause merely a�ects the value of the Lease rather thanits �nanceability. That argument may be correct, assuming anarrower use clause remains broad enough so LeaseholdMortgagee can still easily resell the Lease after a ForeclosureEvent.

19 Landlord may also want to assure that, even if theSublease is at market, Subrent does not decline over time andSubtenant agrees to pay Subrent upon request (and anySublease termination payments) directly to Landlord.

20 Landlord (and its Fee Mortgagees) may hesitate to‘‘nondisturb’’ (or more often ‘‘recognize’’) all future Sub-tenants, even under the conditions stated. Landlord mayargue that once the Lease terminates, Landlord should re-cover clear possession of the entire Premises, without havingto deal with any bits or pieces of Tenant's failed plan for thePremises. Subtenants that make substantial investments intheir space (and Tenant and Leasehold Mortgagee) will feelotherwise, and will usually win this discussion.

21 The possibility of a Loss and its variations oftenconsume many pages in a Lease. The parties can negotiateand �ne-tune this topic, and create new categories, distinc-tions, and conditions, to whatever degree they want or canstand. Of all the issues these Leasehold Mortgagee Protec-tions cover, the treatment of a Loss may be the one leastsuited to a ‘‘one size �ts all’’ resolution, but also the onewhere cost-bene�t considerations most cry out for it. TheseLeasehold Mortgagee Protections make a valiant e�ort. Onelawyer has proposed, not entirely as a joke, that the govern-

ment should: (a) prohibit all condemnation clauses; (b)require any condemning authority to compensate each holderof an interest in the condemned property for the separatevalue of that interest; (c) collect a minuscule fee from eachreal estate transaction to establish a condemnation under-compensation protective fund; and (d) use that fund to makewhole any real property owner ever undercompensated for acondemnation.

22 Even if Landlord has agreed to allow just anyone to beLeasehold Mortgagee, Landlord can legitimately set stan-dards for who may hold Loss Proceeds.

23 On the issue of a temporary condemnation, silence willusually su�ce.

24 Tenant may want to cap or narrow these expenses, ortreat them as a risk of ownership.

25 Leasehold Mortgagees often want Loss Proceeds to go�rst to repay all Leasehold Mortgages in full. This may beunreasonable, based on the following arguments. A condem-nation clause should give each party a package that re�ectsthe value and relative risks/bene�ts of its position under theLease if the Lease had continued. Neither party should �nditself in a better position (wealthier) after a condemnationthan before. Absent condemnation, Landlord would hold alow-risk high-priority relatively �xed annuity (much like a�rst fee mortgage, see, e.g., ‘‘Special Report: CMBS:Moody's Approach to Rating Loans Secured By GroundLeasehold Interests,’’ October 23, 2001). In contrast, asholder of a higher-risk and lower-priority interest in the realestate, Tenant (and its mortgagees) would bear the risk of‘‘�rst loss’’ if the value and cash �ow of the property couldnot adequately support Landlord, Tenant, and their lenders.To do justice to these positions after a single unexpected‘‘liquidation’’ of the Premises because of a Loss, Landlordshould be paid �rst, but only to the extent of the value ofLandlord's low-risk annuity under the Lease, including thereversion. Tenant should own what's left: the risk of inade-quate Loss Proceeds, and the possible windfall of excessiveLoss Proceeds. In response to these issues, some Leases sayLandlord and Tenant share Loss Proceeds in proportion tothe relative values of their positions. Landlord may fear thatany formula tied to the value of Landlord's position at themoment of condemnation may undercompensate Landlord ifa condemnation occurs during high interest rates or an anom-alous real estate market, such as the market that existed in1991. This undercompensation is much like the loss amortgagee su�ers under 11 U.S.C.A. §§ 506(a) and1129(a)(7), which let a debtor ‘‘cram down’’ a mortgageebased on current adverse circumstances - temporary impair-ment of value of the collateral—at the moment of a bank-ruptcy �ling, even though the mortgagee thought it hadbought into the real estate for the long haul. The condemna-tion formula can set a �oor for Landlord's share of the award,taking into account such factors as the remaining term, amaximum discount rate, and a minimum projected residualvalue. Any such protection will create a corresponding riskfor Tenant and Leasehold Mortgagee (a ‘‘zero-sum game’’).Some of this risk may be insurable.

26 Landlord may want to add a decision deadline. Withoutone, the courts will infer a ‘‘reasonable’’ time, creating toler-able uncertainty. If a Lease is fully nonrecourse, then: (a)Tenant has a termination option at all times; (b) a furthertermination option might be a waste of words, so long asTenant must unambiguously leave behind all Loss Proceeds


if Tenant ever just ‘‘walks away’’; and (c) a Loss-basedtermination becomes interesting only when Tenant wants theright to terminate and yet keep some Loss Proceeds, a pos-sibility not provided for here.

27 A ‘‘Termination Option Loss’’ lets Tenant decidewhether to terminate. In such a case, Landlord would reason-ably argue that Landlord should keep Loss Proceeds, or Ten-ant should nevertheless restore. Tenant and LeaseholdMortgagee may disagree. Landlord would say that Landlord'sclaim to the value of the improvements should defeat theclaim of the �ckle Tenant and Leasehold Mortgagee, who‘‘chose to walk away.’’ If, however, Tenant and LeaseholdMortgagee had no real choice, then Landlord's‘‘expectation’’-based claim to Loss Proceeds seems weaker.For example, if a 60-story o�ce building was originally a‘‘legal nonconforming use’’ but current code allows restora-tion only as a single-family residence, or if the condemnortook 95% of the site (either, a ‘‘Total Loss’’), then Landlordstill receives its �rst-priority claim for any resulting diminu-tion in the Leased Fee Value, but any remaining LossProceeds (typically the value of the improvements) go toTenant and Leasehold Mortgagee.

28 Tenant and Leasehold Mortgagee cannot just ‘‘take themoney and run.’’ Landlord has its own independent and le-gitimate interest in seeing the Premises restored. But whathappens if Loss Proceeds are insu�cient to restore asrequired? Typically a Lease will require Tenant to make upthe shortfall before starting work, but that obligation will notbe personally guarantied. If at that point Tenant chose to‘‘walk away,’’ then Landlord would receive the remainingLoss Proceeds. The Leasehold Mortgage loan documents willalso have something to say about this issue. Landlord willwant some ability to control how Tenant restores thePremises. This will raise the same issues as any other majorconstruction project on the Land and usually justify the sameoutcomes.

29 These Leasehold Mortgagee Protections do not requirethat any Fee Mortgage must be ‘‘subordinate’’ to everyLeasehold Mortgage. That issue is a can of worms causedmostly by confusion about leasehold transactions. Instead,this paragraph tries to explain very succinctly how Fee Mort-gages, the Lease, and Leasehold Mortgages interact.

30 Tenant should agree, in the Leasehold Mortgage, noteven to try to subordinate the Lease to any Fee Mortgage.Landlord or Fee Mortgagee may suggest that Fee Mortgagee:(a) be superior and prior to the Lease, but (b) enter into anabsolute and unconditional nondisturbance agreement withTenant and Leasehold Mortgagee. Tenant and LeaseholdMortgagee typically reject that proposition in short order, inpart because it might be treated as an executory contract inFee Mortgagee's bankruptcy. They may, however, reluc-tantly tolerate a prior Fee Mortgage if Fee Mortgagee ‘‘joinsin’’ the Lease when the parties sign it—a joinder in the pres-ent creation of a property interest rather than an ‘‘executo-ry’’ promise to do something later. As another option, theFee Mortgage could be expressly subordinate to the Lease,except during any period when Fee Mortgagee is bound by afully e�ective nondisturbance agreement in the form theLease requires. If the nondisturbance agreement goes away,so does the subordination of the Lease.

31 Fee Mortgagee may want the right to cure Landlorddefaults. Given the limited scope of Landlord's obligationsunder a Lease, Fee Mortgagee's cure rights can be simpler

than Leasehold Mortgagee's. But Fee Mortgagee cure rightsare neither relevant to �nanceability of Leases nor uniformlyincluded in Leases.

32 The parties may want to say that Leasehold Mortgag-ee's rights end when Tenant has repaid its loan. This seemsobvious and hence unnecessary. Silence avoids the need toidentify, de�ne, and carve out loan repayments that shouldnot terminate Leasehold Mortgagee's rights (e.g., thoseresulting from a Foreclosure Event).

33 Without Leasehold Mortgagee's consent, any Leaseamendment is not even e�ective as between Landlord andTenant. This may be overkill, but it prevents issues, complex-ity, and controversy that might arise if some amendmentswere e�ective between Landlord and Tenant but did not bindLeasehold Mortgagee.

34 If the parties disagree over an alleged Tenant Default,Leasehold Mortgagee may want the right to pay under protestand obtain a refund if Leasehold Mortgagee wins the �ght.Such a provision probably duplicates what any court woulddo anyway under the circumstances. It does not seem es-sential to �nanceability, as its absence should not create in-tolerable risks. Leasehold Mortgagee will want to con�rmthat Tenant has ample cure periods and dispute rights evenbefore Leasehold Mortgagee's cure period begins.

35 Landlord may want a shorter cure period for failure toinsure. Although this sounds compelling, it is probably notrealistic. Landlord should rely on its own (and LeaseholdMortgagee's) monitoring, a 30-day notice requirement forcancellation, and, if necessary, the ability to expeditiouslyforce-place single-interest coverage at Tenant's expense.

36 Landlord may argue that this gives Leasehold Mort-gagee too many bites at the apple and, for example, LeaseholdMortgagee should lose its New Lease rights if at any timeany monetary obligation was more than �� days past due.Leasehold Mortgagee usually wins this discussion.

37 If a dispute exists about any of these items, LeaseholdMortgagee may want a New Lease even while the dispute isbeing resolved.

38 From Lease termination until New Lease execution,the Lease could set rules to govern Landlord's interim leas-ing program, Subleases, operations, and so on. Given howrarely (if ever) any Landlord has ever terminated a Lease andthen entered into a New Lease, the topic probably does notmerit the attention it sometimes receives. These LeaseholdMortgagee Protections cover it in a minimal and ‘‘broadbrush’’ way.

39 The preceding sentence is not standard, but some sec-ondary market players want it.

40 This assignment should also appear in the LeaseholdMortgage and loan documents.

41 Many Leases address the Bankruptcy Termination Op-tion at length. Everything they say boils down to this sentenceand the de�nition of Lease Impairment. If Landlord rejectsthe Lease in bankruptcy and Tenant does not exercise theBankruptcy Termination Option, then Tenant can o�set dam-ages against rent. Incorrect o�sets can conceivably lead toLease terminations. Thus, some Leases let Leasehold Mort-gagee approve and con�rm each o�set. These LeaseholdMortgagee Protections contain no such procedures, because:(a) such o�sets are quite rare (the author will pay $1.00 toanyone who can identify one that ever occurred under anymortgaged Lease); and (b) Leasehold Mortgagee can reason-ably protect itself through pre-emptive litigation if necessary.



42 Tenant will want Leasehold Mortgagee not to excludeTenant unless an uncured Event of Default exists. Any suchrestrictions belong in the loan documents, not the Lease.

43 If a proceeding involves a monetary claim of less than$��, perhaps Tenant should be able to settle it withoutLeasehold Mortgagee's consent.

44 The senior Leasehold Mortgagee may want morecontrol than this paragraph grants. All Leasehold Mortgageesneed an intercreditor agreement.

45 This clause ‘‘c’’ governs as between Landlord andLeasehold Mortgagees as a group. The most senior LeaseholdMortgagee might want to go further, reserving the right to

determine that a particular Leasehold Mortgagee Protectionshall not be exercised at all, by anyone. That issue belongs inthe intercreditor agreement among Leasehold Mortgagees,not the Leasehold Mortgagee Protections.

46 Landlord may want Leasehold Mortgagee to commit atsome point that Leasehold Mortgagee will in fact eventuallycure a Tenant Default, especially if construction-related.Leasehold Mortgagee, though, will want a ‘‘right to walk’’at any time, regardless of how long Landlord may have hadto ‘‘wait around,’’ and will point out that all monetary obliga-tions will have been kept current at all times.


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SAMPLE LEASEHOLD MORTGAGE PROVISIONS1

by

Marc S. Intriligator Cozen O'Connor

277 Park Avenue | New York, NY 10172 P: 212.453.3801 | F: 866.832.7201

[email protected] | www.cozen.com July 9, 2015

23. LEASEHOLD MORTGAGES.

23.1 Leasehold Mortgages, Generally. Tenant may mortgage, hypothecate, or pledge

the leasehold estate created hereby and the interest of Tenant in and to this Lease, together with

Tenant’s right, title and interest in the Improvements, subject to the terms of this Lease (herein

called a “Leasehold Mortgage”) for the purpose of financing or refinancing the initial Tenant’s

permitted improvements to the Premises, provided that:

(a) such Leasehold Mortgage shall provide that such Leasehold

Mortgage and the rights of the mortgagee, its successors and assigns thereunder,

are and shall be subject and subordinate to all the terms, covenants and conditions

of this Lease; and

(b) such Leasehold Mortgage shall affect and encumber only, and no

more, than Tenant’s leasehold estate existing at the time of the execution and

delivery of the Leasehold Mortgage, and the right, title and interest of Tenant in

and to the leasehold estate and leasehold improvements.

23.2 Notices to Landlord

(a) If Tenant shall mortgage Tenant’s leasehold estate pursuant to Section 23.1 above,

and if the holder of such Leasehold Mortgage shall provide Landlord with written notice of such

Leasehold Mortgage together with a true copy of such Leasehold Mortgage and the name and

address of the Leasehold Mortgagee, Landlord and Tenant agree that, following receipt of such

notice by Landlord, the provisions of this Article 23 shall apply in respect to such Leasehold

Mortgage.

(b) In the event of any assignment of a Leasehold Mortgage, or in the event of a change

of address of a Leasehold Mortgagee or of any assignee of such Leasehold Mortgage, notice of the

new name and address shall be provided to Landlord in writing.

1 These sample provisions are distributed to those participating in a Stafford Webinar on leasehold financing for

discussion purposes only. No assurance is given that the provisions will satisfy a prospective leasehold mortgagee or

be acceptable to a ground lessor. Also, no opinion or assurance is given that these provisions are comprehensive, will

be determined to be enforceable, or will offer suitable or sufficient protection to any party to, or interested in, a

financeable lease. Note: the contents of various other provisions in a ground lease may be determinative as to whether

the lease is financeable or, if so, the enforceability or effect of the leasehold financing provisions in this handout.

http://www.cozen.com/

2

(c) Landlord shall, promptly upon receipt of a communication purporting to constitute

the notice provided for by subsection (a) above and request of the Tenant and Leasehold

Mortgagee, acknowledge receipt of such communication as constituting the notice provided for by

subsection (a) above or, in the alternative, notify the Tenant and the Leasehold Mortgagee of the

rejection of such communication as not conforming with the provisions of subsection (a) and

specify the specific basis of such rejection.

(d) After Landlord has received the notice provided for by subsection (a) above,

Tenant, upon being requested to do so by Landlord, shall with reasonable promptness provide

Landlord with copies of the note or other obligation secured by such Leasehold Mortgage, and of

any other documents pertinent to the Leasehold Mortgage. Tenant shall thereafter also provide the

Landlord from time to time with a copy of each amendment or other modification or supplement

to such instruments.

(e) The term “Leasehold Mortgagee” as used in this Section 23.2 shall refer to a holder

of a Leasehold Mortgage in respect to which the notice provided for by subsection (a) or (b) hereof

has been given and received, and as to which the provisions of this Section 23.2 are applicable.

23.3 Consent of Leasehold Mortgagee Required. No voluntary termination, surrender,

or modification of this Lease by Tenant shall be effective unless consented to in writing by the

Leasehold Mortgagee.

23.4 Default Notice. Landlord, upon providing Tenant any notice of default under this

Lease or a termination of this Lease, shall at the same time provide a copy of such notice to

Leasehold Mortgagee. No such notice by Landlord to Tenant shall be deemed to have been duly

given unless and until a copy thereof has been so provided to Leasehold Mortgagee. From and

after the date that such notice has been given to Leasehold Mortgagee, Leasehold Mortgagee shall

have the same period, after the giving of such notice upon it, for remedying any default or causing

the same to be remedied, as is given Tenant after the giving of such notice to Tenant, to remedy

the defaults, or with respect to non-monetary defaults, to commence remedying or cause to be

remedied the defaults specified in any such notice. Landlord shall accept such performance by or

at the instigation of such Leasehold Mortgagee as if the same had been done by Tenant. Tenant

authorizes Leasehold Mortgagee to take any such action at such Leasehold Mortgagee’s option

and does hereby authorize entry upon the Premises by the Leasehold Mortgagee for such purpose.

23.5 Notice to Leasehold Mortgagee.

(a) Anything contained in this Lease to the contrary notwithstanding, if any default

shall occur which entitles Landlord to terminate this Lease, Landlord shall have no right to

terminate this Lease unless, following the expiration of the period of time given Tenant to cure

such default, Landlord shall notify Leasehold Mortgagee of Landlord’s intent to so terminate at

least ten (10) days in advance of the proposed effective date of such termination if such default is

capable of being cured by the payment of money, and at least thirty (30) days in advance of the

proposed effective date of such termination if such default is not capable of being cured by the

payment of money. The notice required by this Section 23.5 may be the same notice as the notice

required by Section 23.4 above. The provisions of Section 23.6 below shall apply if, during such

ten (10) or thirty (30) day termination notice period, as applicable, any Leasehold Mortgagee shall:

3

(i) notify Landlord of such Leasehold Mortgagee’s desire to nullify

such notice;

(ii) pay, or cause to be paid, all Rent and other payments then due and

in arrears, as specified in the termination notice to such Leasehold Mortgagee,

during such ten (10) day period; and

(iii) comply, or in good faith, with reasonable diligence and continuity,

commence to comply with all nonmonetary requirements of this Lease then in

default (other than the Personal Defaults identified in Section 23.9) during such

thirty (30) day period.

(b) No notice that Landlord gives Tenant shall be effective unless Landlord has

furnished a copy thereof to Leasehold Mortgagee.

(c) Any notice to be given by Landlord to a Leasehold Mortgagee pursuant to any

provision of this Section 23.5 shall be deemed properly addressed if sent to the Leasehold

Mortgagee who served the notice referred to in Section 23.2(a) or 23.2(b).

23.6 Procedure on Default.

(a) If Landlord shall elect to terminate this Lease by reason of any default of Tenant,

and a Leasehold Mortgagee shall have proceeded in the manner provided for by Section 23.5, the

specified date for the termination of this Lease as fixed by Landlord in its termination notice shall

be extended for a period of ninety (90) days, provided that Leasehold Mortgagee shall:

(i) during the first ten (10) days of such ninety (90) day period, pay or

cause to be paid any Rent then in arrears, and thereafter pay all Rent reserved under

this Lease as the same shall become due;

(ii) during the first thirty (30) days of such ninety (90) day period,

perform all of Tenant’s other obligations under this Lease and commence and

diligently prosecute the performance of non-monetary requirements then in default,

excepting Non-Curable Defaults (defined in Section 23.9 below) and Possession-

Related Defaults (defined in subsection (c) below); and

(iii) during such ninety (90) day period, if not enjoined or stayed, take

steps to obtain possession of the Premises and to acquire or sell Tenant’s interest in

this Lease by foreclosure of the Leasehold Mortgage or other appropriate means,

prosecute the same to completion with due diligence and, thereafter, cure all

Possession-Related Defaults with due diligence.

(b) If, at the end of such ninety (90) day period, such Leasehold Mortgagee is

complying with Section 23.6(a), this Lease shall not then terminate, and the time for completion

by such Leasehold Mortgagee of its proceedings shall continue so long as such Leasehold

Mortgagee is enjoined or stayed and thereafter for so long as such Leasehold Mortgagee proceeds

to complete steps to obtain possession of the Premises and to acquire or sell Tenant’s interest in

this Lease by foreclosure of the Leasehold Mortgage or by other appropriate means with reasonable

4

diligence and continuity, and continues to comply with Section 23.6(a). Nothing in this Section

23.6(b), however, shall be construed to extend this Lease beyond the original term thereof as

extended by any options to extend which may hereafter be granted properly exercised by Tenant

or Leasehold Mortgagee.

(c) If a Leasehold Mortgagee is complying with Section 23.6(a), upon the acquisition

of Tenant’s leasehold estate by such Leasehold Mortgagee or its designee or any other purchaser

at a foreclosure sale or otherwise, this Lease shall continue in full force and effect as if Tenant had

not defaulted under this Lease; provided that the Leasehold Mortgagee shall have completed the

cure of all prior defaults, except Personal Defaults, and shall be diligently completing the cure of

all defaults which require possession of the Premises (“Possession-Related Defaults”).

(d) For the purposes of this Section 23.6(d), the making of a Leasehold Mortgage shall

not be deemed to constitute an assignment or transfer of this Lease or of the leasehold estate hereby

created, nor shall any Leasehold Mortgagee, as such, be deemed to be an assignee or transferee of

this Lease or of the leasehold estate hereby created so as to require the Leasehold Mortgagee, as

such, to assume the performance of any of the terms, covenants or conditions on the part of the

Tenant to be performed hereunder, but the purchaser at any sale of this Lease and of the leasehold

estate hereby created in any proceedings for the foreclosure of any Leasehold Mortgage, or the

assignee or transferee of this Lease and of the leasehold estate hereby created under any instrument

of assignment or transfer in lieu of the foreclosure of any Leasehold Mortgage, shall be deemed to

be an assignee or transferee, and (except for any transfer to the Leasehold Mortgagee itself or any

subsidiary thereof, for so long as Leasehold Mortgagee qualifies as an Institutional Lender, defined

below) shall be subject to any consent or approval by Landlord or required under Section 13.1,2

and shall be deemed to have agreed to perform all of the terms, covenants and conditions on the

part of the Tenant under the Lease then in default except Personal Defaults and those to be

performed hereunder from and after the date of such purchase and assignment; provided, however,

that such assignee or transferee shall remain bound by the provisions of Section 5.1.3 If the

Leasehold Mortgagee or its designee shall become holder of the leasehold estate, and if the any of

the Improvements shall have been or become materially damaged on, before, or after the date of

such purchase and assignment, the Leasehold Mortgagee or its designee shall be obligated to

repair, replace or reconstruct such Improvements only to the extent of the net insurance proceeds

received by the Leasehold Mortgagee or its designee by reason of such damage. As employed

herein, the term “Institutional Lender” shall mean:

(i) any savings bank, savings and loan association, bank or trust

company, insurance company, or educational institution;

(ii) any federal, state, municipal, teachers, or other public employees’

welfare, pension, or retirement trust, fund, or system;

(iii) any other employees, welfare, pension, endowment, or retirement

trust, fund or system having assets of at least $350,000,000;

2 Section 13.1 is the general restriction against assignments without the landlord’s consent. 3 Section 5.1 is the section of the lease governing the permitted uses of the premises.

5

(iv) any real estate investment or mortgage trust the securities of which

are publicly traded;

(v) any Person not referred to above that is subject to supervision and

regulation by the insurance or banking department of any of the United States, the

Board of Governors of the Federal Reserve System, the Comptroller of the

Currency, the Federal Deposit Insurance Corporation, or the Federal Savings and

Loan Insurance Corporation, or by any successor hereafter exercising similar

functions, having assets of at least $350,000,000; or

(vi) any governmental, public, quasi-governmental, or quasi-public

authority, including without limitation IDA or any instrumentality utilized by IDA

for the purpose of financing the Improvements.

(e) Notwithstanding any other provisions of this Lease, any Leasehold Mortgagee

acquiring the leasehold estate of Tenant pursuant to foreclosure, assignment in lieu of foreclosure

or other proceedings may, upon acquiring Tenant’s leasehold estate, sell and assign the leasehold

estate on such terms and to such persons and organizations as are acceptable to such Leasehold

Mortgagee and thereafter be relieved of all obligations accruing thereafter under this Lease;

provided that such assignee has cured all then existing defaults other than Personal Defaults and

delivered to Landlord its written agreement to be bound by all of the provisions of this Lease.

(f) Notwithstanding any other provisions of this Lease, any sale of this Lease and of

the leasehold estate hereby created in any proceedings for the foreclosure of any Leasehold

Mortgage, or the assignment or transfer of this Lease and of the leasehold estate hereby created in

lieu of the foreclosure of any Leasehold Mortgage to any Leasehold Mortgagee, shall be deemed

to be a permitted sale, transfer or assignment of this Lease and of the leasehold estate hereby

created subject to compliance by such Leasehold Mortgage with this Section 23.6.

23.7 New Lease. In the event of the termination of this Lease for any reason, Landlord

shall, in addition to providing the notices of default and termination as required by Sections 23.4

and 23.5 hereof, provide each Leasehold Mortgagee with written notice that the Lease has been

terminated, together with a statement of all sums which would at that time be due under this Lease

but for such termination, and of all other defaults, if any, then known to Landlord. Landlord agrees

to enter into a new lease (the “New Lease”) of the Land with such Leasehold Mortgagee or its

designee for the remainder of the term of this Lease, effective as of the date of termination, at the

Base Rent, and upon the terms, covenants and conditions (including all options to renew but

excluding requirements which are not applicable or which have already been fulfilled) of this

Lease, provided:

(a) Such Leasehold Mortgagee shall make written request upon

Landlord for such New Lease within sixty (60) days after the date such Leasehold

Mortgagee receives Landlord’s notice of termination of this Lease given pursuant

to this Section 23.7.

(b) Such Leasehold Mortgagee or its designee shall pay, or cause be

paid, to Landlord at the time of the execution and delivery of such New Lease any

6

and all sums which would at the time of execution and delivery thereof be due

pursuant to this Lease but for such termination and, in addition thereto, all

reasonable expenses, including reasonable attorney’s fees and disbursements,

which Landlord shall have incurred by reason of such termination and the execution

and delivery of the New Lease and which have not otherwise been received by

Landlord from Tenant or on behalf of Tenant. In the event of a controversy as to

the amount to be paid to Landlord pursuant to this Section 23.7(b), the payment

obligation shall be satisfied if Landlord shall be paid the amount not in controversy,

and the Leasehold Mortgagee or its designee shall agree to pay any additional sum

ultimately determined to be due plus interest (at the Default Rate) and such

obligation shall be adequately secured.

(c) Such Leasehold Mortgagee or its designee shall pay all sums due

under the Lease (subject to the offset in Section 23.8(b), if applicable) and agree to

remedy any of Tenant’s other defaults (other than Personal Defaults) of which said

Leasehold Mortgagee was notified by Landlord’s notice of termination within a

reasonable period.

(d) Any New Lease made pursuant to this Section 23.7, and any renewal

Lease entered into with a Leasehold Mortgagee pursuant to any options hereafter

granted to Tenant under this Lease, shall, if and to the extent provided by Law,

retain the priority of lien which this Lease enjoys, and the lessee thereunder shall

have the right to receive a Non-Disturbance Agreement.

(e) If more than one Leasehold Mortgagee shall request a New Lease

pursuant to this Section 23.7, Landlord shall enter into such New Lease with the

Leasehold Mortgagee whose mortgage is prior in lien, or with the designee of such

Leasehold Mortgagee. Landlord, without liability to Tenant or any Leasehold

Mortgagee with an adverse claim, may rely upon a mortgagee title insurance policy

issued by a responsible title insurance company doing business within the state in

which the Premises are located as the basis for determining the appropriate

Leasehold Mortgagee who is entitled to such New Lease.

23.8 Landlord Bankruptcy. If Landlord shall be the debtor in any proceeding under

laws relating to bankruptcy or insolvency, and if the Lease is rejected by Landlord or by Landlord’s

trustee in bankruptcy:

(a) Tenant shall not have the right to treat this Lease as terminated

except with the prior written consent of all Leasehold Mortgagees; and the right to

treat this Lease as terminated in such event shall be deemed assigned to each and

every Leasehold Mortgagee, whether or not specifically set forth in any such

Leasehold Mortgage, so that the concurrence in writing of Tenant and each

Leasehold Mortgagee shall be required as a condition to treating this Lease as

terminated in connection with such proceeding.

(b) If this Lease is not treated as terminated in accordance with Section

23.8(a) above, then this Lease shall continue in effect upon all the terms and

7

conditions set forth herein, including Base Rent, Additional Rent, and all options

to renew, but excluding requirements that are not then applicable or pertinent to the

remainder of the term hereof. Thereafter, Tenant or its successors shall be entitled

to any offsets against Base Rent and Additional Rent payable hereunder for any

damages arising from such rejection, and any such offset properly made shall not

be deemed a default under this Lease. The lien of any Leasehold Mortgage then in

effect shall extend to the continuing possessory rights of Tenant following such

rejection with the same priority with respect to each such Leasehold Mortgage as it

would have enjoyed had such rejection not taken place.

23.9 Non-Curable Defaults. Nothing herein contained shall require any Leasehold

Mortgagee or its designee, as a condition to its exercise of rights hereunder, to cure any default

specified in Section 16.1(c)4 (“Personal Defaults”) or any Possession-Related Defaults which are

otherwise not reasonably susceptible of being cured by such Leasehold Mortgagee or its designee

(collectively, “Non-Curable Defaults”).

23.10 Eminent Domain. Tenant’s share of any Award, as provided in Section 11.55 of

this Lease shall, subject to the provisions of such Section 11.5, be disposed of as provided for by

any Leasehold Mortgagee.

23.11 Casualty Loss. A standard mortgagee clause naming Leasehold Mortgagee may

be added to any and all insurance policies required to be carried by Tenant hereunder on condition

that the insurance proceeds are to be applied in the manner specified in this Lease and the

Leasehold Mortgage shall so provide; except that the Leasehold Mortgage may provide a manner

for the disposition of such proceeds, if any, otherwise payable directly to the Tenant (but not such

proceeds, if any, payable jointly to the Landlord and the Tenant or to be held in trust under this

Lease) pursuant to the provisions of this Lease.

23.12 Right to Participate. If Landlord or Tenant initiates any appraisal, arbitration,

litigation, or other dispute resolution proceeding affecting this Lease, then the parties shall

simultaneously notify Leasehold Mortgagee. Leasehold Mortgagee may participate in such

proceedings on Tenant’s behalf, or exercise any or all of Tenant’s rights in such proceedings.

Unless Leasehold Mortgagee shall notify Landlord to the contrary, any settlement shall not be

effective without Leasehold Mortgagee’s consent.

23.13 Further Assurances. Upon request from Tenant or any Leasehold Mortgagee,

Landlord shall enter into any modification of this Article 23 that any current or prospective

Leasehold Mortgagee reasonably requests, if the modification does not adversely affect Landlord

in any material respect or reduce or change the timing of any payment this Lease requires, and

provided that Tenant reimburses Landlord for Landlord’s reasonable attorneys’ fees and expenses

in connection therewith.

4 Section 16.1(c) is the default provision dealing with bankruptcy or related proceedings involving the tenant. 5 Section 11.5 deals with the order of distribution of eminent domain awards.

Ground Leases in Property-Specific and Large Loan Transactions*

General

Most stand-alone property-specific and large loan transactions that Standard & Poor's rates involve rated

securities backed by a loan or loans secured by a mortgage on a borrower's fee simple interest in the real

property. Certain transactions, however, involve leasehold financing where the mortgage loan is secured

by a mortgage on the borrower's leasehold interest in the real property rather than the fee interest.

In a typical leasehold financing, the borrower leases the mortgaged property from a landlord, pursuant to

a ground lease. The landlord owns fee simple title to the real estate and leases it to the borrower.

Depending on the circumstances, the buildings and improvements may be owned by the landlord and

leased to the borrower, or owned by the borrower directly. The rights of the mortgagee (as well as the

trustee on behalf of the holders of the rated securities) with respect to the real property are derived

through the borrower's interest in the ground lease and are dependent upon the continued existence of

the ground lease. If the ground lease expires prior to payment in full of the related mortgage loan, the

mortgage loan backing the rated securities could become unsecured.

The risk that the mortgage loan backing the rated securities will not be secured as a result of the

termination of the ground lease is alleviated when the landlord subordinates and subjects its fee simple

interest in the real property to the interests of the mortgagee by executing the mortgage. As a practical

matter, this situation is similar to the situation where the borrower owns fee simple title to the real estate

and the buildings and improvements and mortgages that fee simple interest. In the event the borrower

defaults on its obligations, the mortgage holder may exercise its right to foreclose on the real property and

extinguish the landlord's interest in the real property.

Ground Lease Provisions

Frequently, however, a landlord is unwilling to subordinate and subject its fee simple interest in the real

property to a leasehold mortgage. If the landlord does not subordinate and subject its fee simple interest

in the real property to the leasehold mortgage, certain provisions must be included in the ground lease or

a separate document to protect the mortgagee (and the holders of the rated securities) from the risk of

termination of the ground lease prior to payment in full of the related mortgage loan or liquidation of the

collateral securing such mortgage loan. Accordingly, Standard & Poor's may review the ground lease (or

*Excerpted from U.S. CMBS Legal And Structured Finance Criteria: Property-Specific And Large Loan

Transactions by James Palmsiano & Majid Geramian, published on May 1, 2003 by Standard & Poor’s Ratings

Services, a division of The McGraw-Hill Companies, Inc. This material is reproduced with the permission of the

publisher.

2

an abstract thereof) in stand-alone property-specific and large loan transactions to assess whether such

adequate protections exist.

Although the following list is by no means exhaustive or mandatory in every case, it includes those items

that Standard & Poor's typically expects to be satisfied in a stand-alone property-specific or large loan

transaction involving mortgages securing leasehold interests.

• Memorandum of lease. In most jurisdictions, the ground lease or a

memorandum of lease must be recorded in the applicable local land

records.

• Recognition of borrower as tenant. If the borrower is not the original

tenant under a ground lease, the borrower must have acquired its

interest in the ground lease in accordance with the terms of the ground

lease and the borrower must be recognized by the landlord.

• Term. The ground lease has a term that extends not less than (i) in the

case of a mortgage loan that fully amortizes by its maturity date, ten

years beyond the maturity date of the related mortgage loan; (ii) in the

case of a mortgage loan that has a balloon payment on its maturity

date, twenty years beyond the maturity date of the related mortgage

loan; and (iii) in the case of a mortgage loan that has a maturity date

by which the loan substantially amortizes but has an anticipated

repayment date on which the borrower is expected and entitled to

repay the loan to avoid an increase of the interest rate after the

anticipated repayment date, ten years beyond the final maturity date.

This increases the likelihood that there will be sufficient value

remaining in the leasehold interest to allow for a sale or refinancing

that will generate sufficient proceeds to repay the mortgage loan at

maturity.

• Notice of default. Because the landlord's ability to terminate the ground

lease typically arises upon the borrower's default in its obligations

under the ground lease, the landlord should give the trustee, on behalf

of the holders of the rated securities, written notice of the borrower's

default prior to and as a condition of the landlord's exercising any

remedy under the ground lease (including, but not limited to, a

termination of the ground lease). This notice permits the trustee, on

behalf of the holders of the rated securities, to monitor the borrower's

3

actions under the ground lease and to prevent a termination of the

ground lease.

• Right to cure. The landlord should grant the trustee, on behalf of the

holders of the rated securities, a right to cure the borrower's default

under the ground lease. Again, this gives the trustee, on behalf of the

holders of the rated securities, the ability to prevent a termination of the

ground lease.

• Termination-option to execute new lease. The landlord should agree

that it will enter into a new ground lease with the trustee, on behalf of

the holders of the rated securities, in the event the ground lease is

"terminated" for any reason, including, but not limited to, a rejection of

the ground lease in the event of a bankruptcy of the borrower. This

provides the trustee, on behalf of the holders of the rated securities,

with the additional protection against the termination of the ground

lease.

• Assignment and subletting. The borrower should be entitled to assign

the lease to the trustee, on behalf of the holders of the rated securities,

and to mortgage its leasehold interest in favor of the trustee, on behalf

of the holders of the rated securities. There should not be any

commercial unreasonable limitations on the right of the ground lessee

to enter into leases with tenants of space in the improvements.

• Insurance and condemnation proceeds. The trustee, on behalf of the

holders of the rated securities, should be entitled to participate in any

settlement regarding insurance and condemnation proceeds and to

supervise and control the receipt of such proceeds. The landlord and

the borrower should not be able to cancel the ground lease for damage

or destruction as long as the leasehold mortgage is outstanding.

• No cancellation. The landlord should agree that the ground lease

cannot be cancelled, surrendered, amended, altered, or modified

without the prior written consent of the trustee, on behalf of the holders

of the rated securities.

Ground Lease Representations and Warranties

Borrowers who finance their leasehold interests in real property typically make the following

representations and warranties with respect to any mortgage that is secured in whole or in part by the

interest of a borrower as a lessee under a ground lease (the applicability of these representations and

4

warranties will vary depending on whether or not the ground lessor's fee interest is subordinated to the

lien of the mortgage):

• Fee encumbered. The mortgage loan is also secured by the related fee

interest in the mortgaged property and the mortgage does not by its

terms provide that it will be subordinated to the lien of any other

mortgage or other lien upon such fee interest, and upon the

occurrence of an event of default under the terms of the mortgage by

borrower, the mortgagee has the right to foreclose or otherwise

exercise its rights with respect to the fee interest within a commercially

reasonable time. This representation is applicable if the related

mortgage does encumber the related lessor's fee interest in such

mortgaged property. This representation frequently is not applicable.

(However, in such cases, the remainder of the ground lease

representations remain applicable.)

• Recording. The ground lease or a memorandum thereof has been duly

recorded, the ground lease permits the interest of the lessee to be

encumbered by the related mortgage, and there has not been a

material change in the terms of the ground lease since its recordation,

with the exception of written instruments that are part of the related

mortgage file.

• No senior liens. Except for the permitted exceptions, the ground

lessee's interest in the ground lease is not subject to any liens or

encumbrances superior to, or of equal priority with, the related

mortgage, other than the related ground lessor's related fee interest.

• Ground lease assignable. The borrower's interest in the ground lease

is assignable to the trustee upon notice to, but without the consent of,

the lessor (or, if any such consent is required, it has been obtained

prior to the closing date) or, in the event that it is so assigned, it is

further assignable by the trustee and its successors and assigns upon

notice to, but without a need to obtain the consent of, the lessor.

• Default. As of the closing date, the ground lease is in full force and

effect and no default has occurred under the ground lease and there is

no existing condition that, but for the passage of time or the giving of

notice, would result in a default under the terms of the ground lease.

5

• Notice. The ground lease requires the lessor to give notice of any

default by the lessee to the mortgagee; or the ground lease, or an

estoppel letter received by the mortgagee from the lessor further

provides that notice of termination given under the ground lease is not

effective against the mortgagee unless a copy of the notice has been

delivered to the mortgagee in the manner described in the ground

lease.

• Cure. The mortgagee is permitted a reasonable opportunity (including,

where necessary, sufficient time to gain possession of the interest of

the lessee under the ground lease) to cure any default under the

ground lease that is curable, after the receipt of notice of any the

default, before the lessor may terminate the ground lease.

• Term. The ground lease has a term that extends not less than (i) in the

case of a mortgage loan that fully amortizes by its maturity date, ten

years beyond the maturity date of the related mortgage loan; (ii) in the

case of a mortgage loan that has a balloon payment on its maturity

date, twenty years beyond the maturity date of the related mortgage

loan; and (iii) in the case of a mortgage loan that has a maturity date

by which the loan substantially amortizes but has an anticipated

repayment date on which the borrower is expected and entitled to

repay the loan to avoid an increase of the interest rate after the

anticipated repayment date, 10 years beyond the final maturity date.

• New lease. The ground lease requires the lessor to enter into a new

lease with the lender upon termination of the ground lease for any

reason, including rejection of the ground lease in a bankruptcy

proceeding, provided that the lender cures any defaults that are

susceptible to being cured by the lender.

• Insurance and condemnation proceeds. Under the terms of the ground

lease and the related mortgage, taken together, any related insurance

proceeds will be applied either to the repair or restoration of all or part

of the related mortgaged property, with the mortgagee or an appointed

trustee having the right to hold and disburse the proceeds as the repair

or restoration progresses, or to the payment of the outstanding

principal balance of the mortgage loan together with any accrued

interest thereon.

6

• Subleasing. The ground lease does not impose restrictions on

subletting that would be viewed as commercially unreasonable by a

prudent commercial mortgage lender.

• Amendments. The ground lease provides that no amendments,

changes, cancellations, alterations, surrender, or modifications may be

made to the ground lease without the consent of the mortgagee.

• Transfer notices. To the extent required by any loan documents, or the

ground lease, or the ground lessor estoppel certificate, all notices of

the transfer of the loan to the trustee for the benefit of the holders of

the rated securities have been delivered or will be delivered

contemporaneously with the closing of the securitized transaction.

Landlord Estoppel Certificate

As a supplement to a review of the ground lease, Standard & Poor's may, depending on the

circumstances, request the delivery of an estoppel certificate from the landlord. This serves as a means

for verifying certain terms of the ground lease and verifying that, as of the closing of the transaction, there

is not a default by the borrower under the ground lease. If executed by the landlord and the borrower, the

estoppel certificate may be expanded to include covenants and obligations undertaken by the landlord

that are not included in the ground lease but are listed above as features that should be included in the

ground lease. The estoppel certificate should be executed by the landlord and identify and certify, as to

the ground lease, the following matters:

• A description of the leased premises;

• The commencement and expiration dates of the ground lease and any

renewal terms thereof;

• The basic, along with additional and percentage, rents, all pass-

throughs of taxes, expenses, or other items, and all other sums

payable by the borrower to the landlord including, if applicable, utility

charges during the original and any renewal terms of the ground lease;

• The amount of any escrows and deposits held by the landlord under

the ground lease;

• That the landlord recognizes and consents to the mortgage in favor of

the trustee, on behalf of the holders of the rated securities;

• That the ground lease contains all of the understandings and

agreements between the borrower and the landlord, and is in existence

in full force and effect, without modification, addition, extension, or

7

renewal. Any such modifications to the ground lease should be

specifically described;

• That there are no options, rights of first refusal, termination, renewal, or

extension rights, exclusive business rights, or other rights to extend or

otherwise modify the ground lease. Any such options or rights should

be specifically described;

• That the borrower is not in default under the ground lease and is

current in the payment of the rents. Any such default should be

specifically described;

• That the landlord is not in default under the ground lease. Any such

defaults should be specifically described;

• That neither the landlord nor the borrower has assigned the ground

lease or sublet the leased premises. Any such assignment or

subletting should be specifically described;

• That the borrower has no defense, set-offs, basis for withholding of

rent, claims, or counterclaims against the landlord for any failure of

performance of any of the terms of the ground lease. The landlord has

no actual knowledge of any claims by others against the borrower

relating to the mortgaged property or its use;

• That the landlord has not assigned, conveyed, transferred, sold,

encumbered, or mortgaged its interest in the ground lease or the

leased premises and there are not mortgages, deeds of trust or other

security interests encumbering the landlord's fee interest in the leased

premises. No third party has any option or preferential right to

purchase all or any part of the leased premises;

• That the landlord has not received written notice of any pending

eminent domain proceedings or other governmental actions or any

judicial actions of any kind against the landlord's interest in the leased

premises; and

• That the landlord has not received written notice that it is in violation of

any governmental law or regulation applicable to its interest in the

leased premises and its operation including, without limitation, any

environmental laws or the Americans with Disabilities Act, and has no

reason to believe that there are grounds for any claim of any such

violation.

8

Standard & Poor's Financial Services LLC (“S&P”) does not guarantee the accuracy,

completeness, timeliness or availability of any information, including ratings, and is not

responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for

the results obtained from the use of ratings. S&P GIVES NO EXPRESS OR IMPLIED

WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF

MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. S&P

SHALL NOT BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, EXEMPLARY,

COMPENSATORY, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES, COSTS,

EXPENSES, LEGAL FEES, or LOSSES (INCLUDING LOST INCOME OR PROFITS AND

OPPORTUNITY COSTS) IN CONNECTION WITH ANY USE OF RATINGS. S&P’s ratings

are statements of opinions and are not statements of fact or recommendations to purchase, hold

or sell securities. They do not address the market value of securities or the suitability of

securities for investment purposes, and should not be relied on as investment advice.

NYSBA N.Y. Real Property Law Journal | Winter 2014 | Vol. 42 | No. 1 17

Although some commentators may have seen a trend toward this type of formula, I have not seen it. Like many of the comments in this article about “typical” practice, my failure to note the trend might only refl ect the particular universe of ground lease transactions that I have personally been involved with or seen recently. Or it could refl ect a view in the market that in the long run—i.e., multiple business cycles—six or seven percent has worked reasonably well, and that there’s no reason to believe it will stop working anytime soon.

Of course, if a “typical” rent reset occurs in a real estate depression—or at any time when valuations use very high capitalization rates—the lessee may get lucky.

As an alternative, a ground lease could theoretically refer to some objective third-party index for long-term capitalization rates for real estate investments at the time of the rent reset. And, very occasionally, the revaluation might direct the apprais-ers to determine the new rent based generally on market conditions for newly negotiated ground leases at the time of the rent reset. In other words, the rent would adjust to equal “fair market rental value” at the time of adjustment, without using any formula to derive the rent adjustment from land value or anything else. The drafters of the ground lease must still defi ne with absolute clarity how fair market rental value is to be deter-mined. They also must defi ne any assumptions the appraisers should consider in that process.

VALUATION ON A RANGE OF DATES • Ground lease negotia-tors sometimes suggest that instead of valuing the site on a specifi c date, the valuation should look to a range of dates, using the average value over, say, a three- or fi ve-year period whose midpoint is the intended rent reset date.

more conservative than developers and investors, will likewise fear that a massive increase in ground rent at some distant date will diminish or destroy the security for their loans. Though “cowboy” developers may sometimes take risks, lenders rarely have the same mindset, and they never forget that the obligation to pay ground rent is always structur-ally senior to any leasehold lender’s collateral.2

In response to these concerns, a lender or prospective lessee will sometimes suggest a “cap” on ground rent adjustments. Typically, though, a lessor will regard any such proposal as a non-starter, because it necessar-ily undercuts the protection that the lessor wanted to achieve through the future ground rent adjustments.

Applying a fi xed percentage to future land values will create problems for both a lessee and its lender—and wonderful results for the lessor—if, at the moment of the rent reset, valuations in the larger real estate market use capitalization rates signifi cantly below six percent. At any such time, real estate values will refl ect a capitalization of future income at, say, four percent, but the ground lease will require payment of ground rent at, say, six percent of that capitalized amount, which may put the lessee in an untenable position and undercut or destroy the value of the lender’s collateral.

LINKAGE TO INTEREST RATES? • Some ground leases try to mitigate these risks by replacing a fi xed adjustment percentage with a percentage tied to interest rates at the time of the rent reset. The parties might choose a long-term rate like 20-year Treasury securities, or, more unusually, they might use a shorter-term one like the prime rate. In either case, they would look at the average level of that rate over some period and then add on some spread.

When a property owner and a de-veloper negotiate a long-term ground lease of a development site, one issue overshadows almost all others: how should ground rent adjust over time to protect the property owner, as les-sor, from infl ation? And how can the lessor participate in future increases in value of this particular site, which may or may not correlate with infl a-tion? At the same time, though, how can the developer assure that its leasehold position will also maintain its value without becoming over-whelmed by rent payments that no longer make any business sense?

TYPICAL APPROACH • Lessors and lessees typically resolve these concerns by agreeing that every two or three decades, they will reappraise the development site that the lessor originally delivered to the transac-tion. In my experience, the ground rent will then adjust to equal six or seven percent of the then-current fair market value of the site, i.e., whatever someone would pay to purchase the development site. Until that happens, rent may go up a bit every year or few years1—or not, especially in older ground leases. In most cases, the rent never drops.

The reference to six or seven per-cent in rent adjustment formulas has remained remarkably stable for quite a while, even through the very low interest rates of the last few years.

Although ground leases typically use the approach just described, pro-spective ground lessees sometimes worry that if a ground rent adjust-ment occurs in a low-interest rate pe-riod like today’s, the typical approach may overcompensate the lessor, leaving the lessee paying ground rent that may feel excessive. Once the ad-justment occurs, this approach might diminish or even destroy the value of the leasehold estate.

LENDER’S CONCERNS • Leasehold lenders, generally even

The Most Important Issue in Every Ground LeaseBy Joshua Stein

18 NYSBA N.Y. Real Property Law Journal | Winter 2014 | Vol. 42 | No. 1

ment potential of raw land (assumed to be unimproved) and the actual physical development that exists on the site at the time of any rent reset.

For example, changes in zon-ing or other law could change the value of the site, if it were priced as hypothetical raw land. For the rent reset, though, the parties need to think about one minor detail: if the transaction played out as the parties originally anticipated, then by the time of the rent reset the lessee will have already built improvements on the land. At the time of the rent reset, those improvements will probably not be obsolete—i.e., ready for demo-lition or major redevelopment.

If zoning at the time of the rent reset would allow much more de-velopment than the building already in place at that time, then that up-zoning does not help the lessee very much. If the lessee must pay rent for newly created development potential that the lessee cannot really use, then the lessee’s leasehold may no longer make economic sense. Conversely, if zoning changes have reduced the permitted development on the site, but the lessee’s improvements are now overbuilt and can remain as a legal nonconforming use, then the lessor would argue that the revalua-tion process should ignore the down zoning.

Another question along those same lines: should newly discovered environmental issues affect the land value? The answer will depend in part on which party bears the risk of unexpected environmental condi-tions, taking into account the terms of the ground lease. And what if some government decides to issue a landmark designation for the existing improvements?

Lessors and lessees might also fi nd themselves fi ghting over wheth-er any appraisal of the land should, in appraising the land, “consider the terms of the lease,” a concept that appears in many older ground rent adjustment clauses and a few newer ones. The whole concept seems

ed on the site when the parties signed their lease, or whatever improve-ments exist at the time of revaluation? This is a common disagreement. The lease should entirely pre-empt it. In general, the appraiser should try to replicate whatever existed when the parties signed the lease, usually vacant land. To avoid confusion, the lease should say that as clearly as possible.

GROUND LEASES OF MORE THAN JUST GROUND • If im-provements existed at lease incep-tion, and the lessor initially demised those improvements to the lessee along with the underlying “ground,” the market will often still regard the transaction as a “ground lease,” even though it covers existing improve-ments and not just ground. The characterization as a “ground lease” would depend largely on whether the lessee’s rights and obligations looked more like ownership (an investment transaction and typically regarded as a ground lease) or mere rights of occupancy not readily salable or fi nanceable in the market (a “space lease”).3

If a ground lease covers improve-ments that existed at the time of lease inception, the rent reset should usu-ally consider only the improvements as they existed at that time. The rent reset clause might, however, require the appraisers to take into account any upgrading or expansion that the lessee accomplished. This effectively forces the lessee to pay rent in ex-change for value that the lessee rather than the lessor created or provided. Forcing the lessee to pay twice for whatever (re)development the lessee accomplished—once when doing the work, a second time by paying adjusted rent based on the completed work—hardly seems “fair.” Fair or not, the lease language should resolve that question and not leave it to courts, appraisers, and arbitrators.

FUTURE CHANGES IN THE SITE • Any ground lease negotiator also should consider possible future disconnects between the develop-

That approach may make some sense. Suppose a rent reset used a single fi xed valuation date of October 1, 2008, two weeks after the Lehman Brothers bankruptcy fi ling. Given the state of the fi nancial and commercial real estate worlds on that date, the lessor would probably feel victim-ized by a very low valuation. Going forward, that particular lessor might favor using an average of the val-ues on multiple dates over multiple years.

Valuation on a range of dates would not need to require a complete reappraisal each time; perhaps the only full appraisal would precisely tie to the midpoint date. The other dates could require only adjusted apprais-als, taking into account only certain elements of the appraisal analysis, such as then-current capitalization and vacancy rates.

Lessors and lessees generally prefer, however, to avoid the time, expense, and logistical diffi culties of dealing with multiple appraisal dates. They tend to feel that way even though an average of multiple appraisals might make the calcula-tion less arbitrary. The use of a single bright-line date introduces a greater element of luck for both parties, but both seem generally willing to take their chances.

The need to periodically revalue the site for the purposes of ground rent adjustment practically invites litigation or arbitration. For obvious reasons, lessor and lessee will have dramatically different ideas of the value of the land, or of how the ap-praisers should proceed, particularly as markets and other circumstances change. The exact wording of the ground lease, and how it addresses those possible changes, becomes crucially important in determining what exactly the appraisers should appraise and how they should go about it.

For instance: should the apprais-ers appraise raw land, or should they include improvements? Should they include the improvements that exist-


sors and lessees often still take their chances, recognizing that there may be surprises while comforting them-selves by knowing that this is the way everyone does it (or at least many people do it), and that lenders have underwritten and fi nanced similar leaseholds for decades.

IS THERE A BETTER WAY? • Lessors and lessees do sometimes try to fi nd a logically superior and per-haps less risky way to handle ground rent adjustments. They often start by suggesting that the ground rent should refl ect the lessee’s revenues, at least in part. The lessor could receive some percentage of “gross revenues,” perhaps after modest deductions, and perhaps with a fl oor. That percent-age might refl ect the expected ratio between the value of the land and the value of the lessee’s completed development project.

It sounds reasonable. But what if the lessee does not try very hard to rent space in the completed develop-ment project? Or occupies the space itself to conduct business? Or sub-leases the space to a chain store at below-market rents while simultane-ously entering into an above-market lease with the same chain store in another state? What if the lessee does a lousy job with subleasing, or fails to invest the capital necessary to achieve the highest rents? And what should the lease allow the lessee to deduct? Leasing costs? Capital expenditures necessary to attract space lessees? If the lessee borrowed money to im-prove the property, should the lessee have the right to deduct debt service? Interest? At what rate? How does the lessor know the lessee is not lying or artifi cially reducing its revenues? Before long, the exercise reinvents the Internal Revenue Code.

If a lessor and a lessee do decide to go down that road, then they (par-ticularly the lessor) should take a few measures to prevent disputes. Keep it dumb and simple, avoiding exclu-sions, complex characterizations, and fi ne lines whenever possible. They all provide fertile ground for misun-derstandings, mischaracterizations,

fun and deep thought resolving them. We shouldn’t give them the chance. Again, the words of the lease should leave no uncertainty.

If the lease has only a decade or two remaining in its term, then an ap-praisal “considering the terms of the lease” should perhaps consider the fact that, as an economic matter, the lessee doesn’t have enough “useful life” left to justify a major construc-tion or redevelopment project. Should the appraisers consider that as a negative in measuring the value of the land “subject to the lease”? Isn’t the short remaining life of the lease a term that ought to be considered?

Over an extended period of time, differences of opinion on these and similar issues translate directly to dollars—lots of them. Any careful lease drafter should prevent the is-sue by avoiding any suggestion that the appraisers should “consider the terms of the lease.” Instead, the ap-praisal clause in the lease should state exactly what circumstances warrant consideration, and what assumptions the appraiser should make. If the appraiser should consider the narrow scope of uses permitted under the lease, that’s what the appraisal clause should say. If other particular provi-sions of the lease should increase or decrease value, identify those. And if the appraiser should disregard the terms of the lease entirely, that’s what the appraisal clause should say.

Anyone writing a land value rent reset clause in a lease should consider asking appraisers whether they can understand and apply the language as written. After all, the hope is that appraisers rather than lawyers or courts will be the parties charged with interpreting and applying the words in the lease.

Even if the lease handles the panoply of appraisal issues correctly, the “standard formula” described above—six or seven percent of land value—will never precisely correlate with what the adjusted rent “should be” according to some “fair” view of the world. It is a crapshoot. But les-

circular. That’s because the value of the lessor’s land, if considered subject to the terms of the lease, will depend largely on the amount of the ground rent, assuming the lessee is reasonably likely to actually pay that ground rent. Thus, it may not make sense—it seems circular—to con-sider the ground rent in measuring the value of the land for purposes of determining the ground rent.

One can eliminate the circularity by deciding that the parties probably meant that any valuation should take into account any lease terms that limit permitted uses or other rights of the lessee.

For example, land will have a higher value if it can be used for “any permitted use.” If, on the other hand, the lease says the lessee can use the site only to construct a “car wash with ancillary coffee shop,” regard-less of what the law might then allow, then that limited range of uses—if ap-plied to the land value as part of the appraisal process—will drive down the value of the land. In this case, “considering the terms of the lease” means accounting for how much those terms decrease the value of the land. It makes sense: if the lease only allows the lessee to construct a car wash with an ancillary coffee shop, the lessee should not pay rent for the right to build a 50-story offi ce build-ing, even if zoning law might allow it.

But “considering the terms of the lease” could also mean something more. It could also mean the apprais-ers should consider anything else in the lease, except ground rent, that increases or decreases the value of the lessor’s position. For example, if the lease gives the lessee a below-market purchase option, this will lower the value of the lessor’s position. And what if the lease requires the lessor to deliver to the lessee some nonstan-dard but expensive service? Is that a term of the lease that the apprais-ers should consider in valuing the land “considering the terms of the lease”? Again, these are fascinating questions. Litigators and courts and expert witnesses could have a lot of


actual earnings, with all the head-aches that entails, but instead based on how much the lessee reason-ably “should have earned” based on market conditions at the time of determination.

If the project consists of a an up-to-date offi ce building, for example, the contingent rent determination could assume the lessee achieves the same occupancy rate and rental levels as other comparable buildings in the market, and expense levels consistent with similar buildings. In each case, the measurement would disregard the lessee’s actual fi nancial performance. The lessee would then pay contingent rent based on these benchmark market-based numbers.

Although this idea may sound practical or at least creative, the par-ties still must consider the possibility of future changes in circumstances, starting with a change of use of the building. And the lessee will worry that circumstances or issues pecu-liar to this property will prevent the lessee from achieving strong enough actual results to match the bench-mark-based contingent rent the lease requires the lessee to pay.

Yet another possibility: the developer might agree to give the lessor a small “carried interest” in the lessee entity. Any carried interest will, however, raise another host of issues, some of them variations on the problems discussed earlier in this article. Many of the carried interest issues will arise from the fact that the developer will probably invest sub-stantial additional capital to generate the anticipated value and return from the project. Another set of problems might arise from the lessor’s concern that the developer could somehow redirect or dilute project income in a way that makes the carried interest worthless. Those two groups of issues only scratch the surface of what a car-ried interest might entail.4

If the parties do not want to agree to any form of contingent ground rent, the question then becomes: how else can the lease protect the lessor

SMALL PERCENTAGES—NOT SO SMALL • Setting aside the many opportunities for dispute that arise in measuring any contingent rent, even a very low percentage of the lessee’s gross revenues, can place a very signifi cant burden on the lessee, and give the lessor a correspondingly signifi cant stream of contingent rent. Suppose, for example, that the lessee agrees to pay the lessor three percent of a truly gross measure of revenue, with no meaningful deductions at all. Three percent sounds like a really small percentage.

Assume, however, that the les-see’s operating expenses, real estate taxes, and insurance consume 50 percent of gross revenue. Assume ground rent consumes another 10 percent and debt service another 20 percent.

After those deductions, the lessee really gets to keep only 20 percent of the gross revenue. The lessor’s three percent share of that gross revenue represents almost one-sixth of the les-see’s bottom line. Moreover, a lessee might operate at a loss even though gross revenue seems substantial. In other words, instead of adding up to 80 percent of gross revenue the lessee’s expenses could add up to 105 percent.

In all these cases, paying even a very small percentage of gross rev-enue to the lessor can put quite a dent in the lessee’s bottom line. Assuming the lessee will consider the concept at all, the lessee might respond in part by trying to credit one ground rent stream against another—similar to the operation of a natural breakpoint with percentage rent in a retail lease or a right for a space lessee to offset real estate tax escalations against percentage rent. Similar consider-ations arise if the lessor will receive a percentage of refi nancings, lease assignment proceeds, or other capital transactions.

As a variation, the parties could conceivably measure the lessor’s participation in the lessee’s operating revenue based not upon the lessee’s

strategizing, gaming the system, and disputes. Try to give the lessor a low percentage of a broadly defi ned vari-able without too many deductions. Gross revenue with no deductions has a lot of appeal to it. Paint with a broad brush. Think about every possible circumstance that might oc-cur and how it might play out given the lease language and defi nitions. Finally, ask an appraiser and a lender how they would interpret, and react to, whatever “brilliant” contingent rent clause the parties think they want to perpetrate.

Any contingent rent formula in a ground lease might also award the lessor a small percentage of capital transactions—lease assignments, refi nancings, or other transactions tantamount to either. Here, too, the principles and issues above will arise, including the risk of recreating the Internal Revenue Code. And, again, any uncertainty about line drawing or inclusions or exclusions will breed disputes down the line.

For example, does a “refi nanc-ing” include the case where a lessee holds its leasehold free and clear, and places an entirely new mortgage on the leasehold? Can it be a “re”-fi nanc-ing if no fi nancing existed before the transaction closed? Does “refi nanc-ing” refer to placing any form of fi nancing on an asset that had previ-ously been fi nanced in some other way at any time, or does it merely refer to replacing one mortgage with another? Should the lessee’s fi rst construction loan be “exempt” from any payment to the lessor? First permanent loan? If multiple sales of the leasehold occur, should the lessor participate only in the “profi t” since the last sale? What about multiple refi nancings over time? If the lessor participates only in the “new loan proceeds,” what if some of those loan proceeds arose only as a result of amortization of the previous loan?

These questions only scratch the surface of the issues that can arise once lessor and lessee start down the contingent rent road.


Although recalibrating relative values has a theoretical appeal to it, it is not at all market standard. In fact it is unheard of. And its appeal is com-plicated by the need to consider ad-ditional capital investment the lessee will make in the project, to upgrade it and increase its value, or even just to keep it functional and rentable on at-tractive terms. If the property’s value as a whole increases as a result of the lessee’s investment and brilliant de-velopment, leasing, and management strategies, how does one slice up the resulting profi ts? The issue becomes particularly troublesome if the lease demises a vacant site; it may be easier in an existing building. But the issues involved may not be all that differ-ent from those that arise whenever a ground lease requires appraisal of anything other than the actual build-ing (and underlying land) on the site at the moment of appraisal.

Because of the ever-shortening duration of the remaining lease term, however, the lessee’s leasehold estate is “supposed to” decline in value over time, requiring some further adjustment, particularly in the last few decades of the lease term. This could take various forms—each with its own unique bundle of trouble—all beyond the scope of this article, and most requiring substantial consump-tion of aspirin.

Instead of looking at relative shares of value, the parties might look at their relative shares of overall property income. The lease might start out by providing for a fi xed rental stream with fi xed bumps. But it could also say that if the lessor’s share of overall gross revenue (or, less desirably, net operating income before ground rent) ever drops below a certain percentage, then the lessor can require an increase in ground rent to bring that percentage back to a certain level. This approach is not too different from the percentage rent dis-cussed earlier. It is also a variation on the technique of “debt service cover-age ratio” from real estate fi nancing, except it refers instead to a “ground

increases given the ever-increasing dollar value of gold, i.e., the plum-meting value of the dollar as against gold.

Lessees, however, would fear a disconnect between the price of gold and the “right” rent, in dollars, for a given site over time. During the last few decades, any such fear would have been entirely justifi ed. Looking ahead, however, a lessor may worry that gold has run its course, or that during the ground lease term gold might no longer function as a reli-able repository of value. A lessor may also worry that a gold clause may not accurately refl ect the future value of this particular site. The lessor might care more about that value than about the general va lue of the dollar.

RECALIBRATION OF RELA-TIVE VALUES • The parties could also try to devise a rent adjustment structure in which, over time, the lessor and the lessee will each main-tain a position whose value always equals about the same percentage of the value of the project as a whole. In other words, whatever rent reset for-mula the ground lease used, it would contemplate a valuation of both the lessor’s and the lessee’s position, after taking into account the contem-plated adjustment. Then the ground lease would also add a requirement—and, to assure it, perhaps another rent adjustment—that at the end of the day each party would maintain about the same percentage of the value of the project as a whole.

For example, if the initial ground rent were calibrated to give the lessor a position worth 34 percent of the project as a whole, then any future ground rent would need to be cali-brated to maintain that percentage, taking into account market conditions at the time of any rent reset. This ap-proach would still require appraisals and the headaches and uncertainties they create. It would, however, at least address each party’s fear that, over time, the rent adjustment would shift too much value into the other party’s pockets.

from infl ation and equitably compen-sate the lessor, while protecting the lessee from destruction of its lease-hold through an unaffordable rent increase?

OTHER INDEXES • One might tie periodic major rent adjustments to an index. For example, rent might rise with the consumer price index. People in real estate, particularly lenders, usually think the CPI goes up faster than real estate values and rents; hence, they may propose a cap on the adjustments.5 But if the parties “cap” any periodic rent adjustment, then the lessor will not achieve its goal of protecting itself from infl ation.

Perhaps the parties can fi nd an index better than CPI; Class A offi ce rents, average daily rate for hotel rooms in a certain market stratum, real estate tax assessments, or retail rents are all possibilities, in each case for some defi ned local geographical area. Real estate professionals may have varying degrees of confi dence in any possible index. They would need to choose accordingly. Future changes in the chosen index would drive changes in the ground rent, regardless of what a particular lessee does or earns in the demised prem-ises. Such an index could make sense, especially if it matched likely uses of the site. A combination of multiple indexes might also work, though it might not ultimately differ signifi -cantly from measuring contingent rent based on a marketplace bench-mark of what the lessee “should have earned,” as suggested above.

Ground leases once required lessees to pay rent equal to the dollar equivalent of a certain amount of gold. The federal government out-lawed such clauses in the 1930s as part of the New Deal. Gold clauses became legal again for any “obliga-tion issued after October 27, 1977.”6 A federal court validated such a clause as recently as 2008.7 Gold clauses certainly would have protected les-sors from infl ation in the recent past. In the last few decades, gold clauses would have produced dramatic rent


nifying glasses and apply them to the lease. It is a reasonable form of free-fl oating anxiety when trying to create something new and different that will work correctly for 99 years.

My own many recent experiences as an expert witness suggest that the commercial real estate industry and the lawyers who serve it categorically overestimate their own intelligence and ability to “get everything right” in the context of ever-more-complex deal structures and terms.9 The more complex and creative the various gradations and nuances become, the more likely the parties will get them wrong, leaving land mines in the lease to produce unpleasant surprises when applied in the real world. The incredibly complex language and multi-page sentences that are so com-mon in today’s real estate documents often manage to include some im-perfection. And, whenever writers of legal documents try to use words to defi ne some future hypothetical that is intended to replicate a set of pres-ent known conditions—pretty much what one does in a land valuation rent reset—the fallibility of lawyers often becomes particularly apparent.

Legitimate fear of complexity, legitimate fear of change, and the constant need to satisfy future lend-ers will often drive ground lease ne-gotiators back to the traditional rent adjustment formula described early in this article.

Endnotes1. These annual increases, typically small,

add up in a signifi cant way over time. They sometimes take the form of a CPI increase, annually or every few years, subject to a low cap. That cap may apply to either: (a) each increase or (b) all increases, considered as a whole, since the start date. Which party will benefi t more from which type of cap will not always be obvious. The measurement of that cap can create room for misunderstandings.

2. This assumes, of course, that the lessor does not agree to join in the leasehold mortgage, sometimes referred to colloquially and incorrectly (and, in the eyes of some courts, almost humorously) as “subordinating the fee.” In today’s market, that assumption is almost always

those cases, the lessee can’t so easily threaten to walk away from the lease, so the lessee truly realizes a benefi t by knowing the adjusted rent before the deadline to exercise the renewal option.8

A more balanced approach might require the lessee to exercise each op-tion before knowing the outcome of the rent determination process, with no right to withdraw the exercise of the option, only the right to walk away from the lease. The renewal options would be disconnected from the rent determination or renegotia-tion process, putting the parties in the same position—and giving each the same leverage—as if the rent adjustment occurred part of the way through the lease term, rather than as part of the renewal process.

Except for the possible need to conform to “tradition,” it seems un-necessary and perhaps even inap-propriate to tie the timing of rent adjustments to the timing of renewal options. In any case, it is not “obvi-ous” that adjustment periods should conform to renewal terms.

REAL ESTATE DERIVATIVES? • Ground lessors and lessees might eventually hedge some risks of real estate infl ation and ground rent ad-justments through insurance or real estate futures markets, in much the same way farmers hedge commod-ity prices. But commercial real estate is not as fungible as pork bellies and corn. And, after some false starts with real estate derivatives during the boom that ended in 2008, it’s safe to assume that brilliant new deriva-tive products are not at the top of anyone’s list. Great fi nancial minds may bridge part of that gap, perhaps by insuring against infl ation through puts and calls involving long-term TIPS bonds. That too has its risks and costs.

Lease negotiators typically worry that creative structures like those proposed in this article will not work right because of some problem or gap that no one notices until the litigation or arbitration begins and the parties and their counsel take out their mag-

rent coverage ratio,” with the goal of keeping it within a certain band.

Conversely, if as a result of those increases in ground rent the lessor’s share ever rose beyond a certain percentage, then ground rent would drop, but never below the fi xed rent schedule. Arrangements like these can give the lessor a form of partici-pation in future upside without open-ing up the possibility of making the leasehold estate uneconomic. But, like so many other alternatives discussed in this article, these arrangements come with tremendous defi nitional issues and hence possible disputes. Moreover, they tempt the lessee to game the system in any number of ways.

RENT ADJUSTMENT TIMING • Anyone who negotiates future con-tingent rent adjustments in a ground lease should also consider how the timing of those rent adjustments interacts with the timing of a lessee’s renewal options. In a lessee’s perfect world, each rent adjustment period would correspond to an option term. The lessee would know the adjusted rent before needing to exercise a renewal option. As an equivalent alternative, the lessee could have the right to withdraw the exercise of an option if the lessee didn’t like the rent as ultimately determined.

Both of those approaches, though perhaps typical, convert each option into a one-way negotiation in which the rent can only go down from what-ever number the rent determination process produced. Of course, the le-verage they give the lessee is roughly equivalent to the lessee’s right to walk from the lease at any time. That walk-away right always gives any lessee the ability to try to negotiate the rent downward at any time. The ability to not exercise—or withdraw the exercise of—a renewal option cre-ates much the same leverage.

The dynamic changes, of course, if the lessee has signifi cant credit or a creditworthy guarantor, or if credit enhancement measures, such as a security deposit or a letter of credit, back the lessee’s obligations. In


Joshua Stein practices commer-cial real estate law in New York City. He chaired the Real Property Law Section for the year ending in May 2006. For more on the author, visit www.joshuastein.com. The author appreciates helpful comments received from Stevens A. Carey of Pircher, Nichols & Meeks, Los Ange-les; Alfredo R. Lagamon, Jr., of Ernst & Young LLP, New York; Donald H. Oppenheim of Berkeley, Califor-nia; Robert M. Safron of Patterson Belknap Webb & Tyler LLP, New York; Lawrence Uchill of Uchill Law, PLLC, Newton, Massachusetts; and Elizabeth T. Power, of the author’s staff. Blame only the author for any errors.

An earlier version of this article appeared in the January 2013 issue of The Practical Real Estate Lawyer. Shorter versions appeared in the [New York] Commercial Observer, June 2012 supplement on mortgage fi nancing, at page 16, and in the December 2012 issue of the Ameri-can College of Real Estate Lawyers Newsletter. Readers are encouraged to comment on and respond to this article by sending email to [email protected]. Copyright (c) 2013 Joshua Stein. All rights reserved.

exposure” may not be all that great. Most leases, including ground leases, allow a lessor only two major forms of recovery upon a lessee’s default. First, the lessor can sue for the rent every month. Second, the lessor can sue the lessee for the excess, if any, of the fair market rental value over the reserved rental for the remaining lease term, discounted to present value. In a typical ground lease, almost by defi nition, no such excess exists: the lease has value to the lessee precisely because the ground rent is below fair market value rather than above fair market value. That fact precludes the lessor from suing for a large and attention-getting lump-sum award if a creditworthy lessee decides to walk away. To recover, the lessor must leave the lease in place and keep suing the lessee every month for unpaid rent, which the lessor might not fi nd too appealing. The comments in this footnote may imply that lessors and their counsel should think more about the measure of damages if a creditworthy lessee does decide to walk away from a ground lease. Of course, the lessor may happily recover possession of a completed building and call it a day.

9. For more on this topic, see Joshua Stein, It’s Complicated, But is it Right?, THE MORTGAGE OBSERVER, February 2013, at 12. The author’s expert witness assignments mostly involve complex and nuanced documents for large transactions. Aside from ground leases, the line-up often includes joint venture agreements; development agreements; intercreditor agreements; and loan documents, particularly nonrecourse clauses and carveouts. With the help of great minds, these documents cover every possible eventuality perfectly except, it seems, the one eventuality that actually occurs; hence, the litigation.

correct, so this article accepts it as part of the territory.

3. Can a ground lease demise part of a building? Must a ground lease demise at least some ground as part of the transaction? To defi ne a transaction as a ground lease, the author would look to the character of the leasehold estate created—the terms of the ground lease—and not place great emphasis on whether the lease demises any ground. Others, including perhaps Black’s Law Dictionary, disagree.

4. Many of these issues also arise in negotiating a joint venture. See Joshua Stein, Agenda for a Joint Venture Agreement, THE PRACTICAL LAWYER, April 2010, at 36, (www.pdf2go.org/165.html).

5. Historically, over any extended period the CPI has actually risen only 2% to 3% a year, despite perceptions of wild infl ation over many years. Some periods of very high infl ation did occur, of course, but looking back over the long term the CPI has not grown all that dramatically. It has certainly not been “out of control” over the long term. Commercial real estate values considered as a whole over the entire United States have trailed the CPI (except in Manhattan, where they have barely matched it). These statements are all wild overgeneralizations—they should not be relied upon in any way or even taken very seriously—but they do summarize the author’s non-authoritative but also nontrivial research in the area. Further insights on these issues will be welcomed.

6. 31 U.S.C. § 5118(d)(2)(1997).

7. 216 Jamaica Ave., LLC v. S & R Playhouse Realty Co., 540 F.3d 433, 441 (6th Cir. 2008).

8. In a typical ground lease, the creditworthy lessee’s “walk-away

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